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ederal   regulation   of   rail- 
Iroad  securities  and  valuation 

bp  RAILROAD  PROPERTIES 


•  • 


,etter  to  the  Railroad  Securities  Commis- 
sion in  Reply  to  their  Request  for 
Information  and  Opinions 


By  Henry  Fink 


385 


TMC 

s  T  ON  e 

PRWTINO-AW) 
nWUBkCTURDW 
COMPANY 


ROANOKe 
VIRGINIA' 


New  York,  December  31,  1910 

Mr.  W.  E.  S.  GRISWOLD,  Secretary, 

Railroad  Securities  Commission, 

Washington,  D.  C. 
Dear  Sir:- 

j  In  answer  to  your  communication  of  the  10th  instant,  I 

^   submit  the  following: 

<i  1.     The  advocates  of  the  supervision  and  control  by  the 

-^    Federal  Government  over  the  issuance  of  stocks  and  bonds 
by  interstate  railroads  appear  to  have  two  objects  in  view; 
— .    the  protection  of  the  investors  in  such  securities  against  over- 
capitalization and  the  protection  of  shippers  against  unreason- 
^^2^^  able  railroad  rates  by  restricting  the  income  of  such  roads  to 
—     what  may  be  considered  a  "reasonable  return  on  the  fair  value 
CH     of  the  property  used  in  the  public  service."     I  do  not  believe 
that  either  of  these  objects  can  be  attained  by  the  proposed 
regulation.     Moreover,   I   think  that  such  regulation  is  not 
needed  and  that  it  woiild  create  conditions  that  must  prove 
harmful  to  the  public  welfare.      It  would  certainly  have  a 
tendency  to  impair  the  credit  of  the  corporations  and   render 
it  difficult  to  borrow  the  money  they  need  in  giving  the  public 
adequate  and  efficient  services.      For  these  and  other  reasons, 
I  deem  such  regulation   to  any   extent   or   by   any  methods 
C  undesirable. 

2.  I  am  not  competent  to  express  an  opinion  as  to  whether 
the  commerce  clause  of  the  constitution,  when  stretched  to 

I  its  utmost  limits,  would  enable  the  Federal  Government  to 

legally  exercise  control  over  the  securities  of  corporations  which 

'  were  created  by  the  states  and  w^hich  are  subject  to  state  laws. 

;;  If  such  control  is  not  exclusive  and  the  corporations  are  made 

I  subject  to  both  Federal  and  state   regulation  in  this  matter, 

it  is  obvious  that  we  will  have  a  multiplication  of  the  evils 
resulting  from  the  existing  dual  control  of  railways.  The 
supervision  and  control  of  the  issuance  of  stocks  and  bonds 
by  the  Federal  Government  seems  to  me  unwise. 

-a  o5oo4 


3.  I  am  of  the  opinion  that  it  is  not  one  of  the  functions 
of  our  government  to  pass  special  laws  for  the  protection  of  any 
one  class  of  investors  and  that  such  laws  are  not  needed  because 
existing  laws  provide  for  the  punishment  of  parties  who  are 
guilty  of  fraudulent  practices  in  connection  with  the  issuance 
of  stocks  and  bonds.  Moreover,  attempts  to  protect  people 
against  the  consequences  of  their  bad  judgment  in  the  selection 
of  securities  for  investments  must  always  prove  futile. 

4.  It  has  been  proved  repeatedly  that  with  the  exception 
of  some  few  cases,  American  railroads  are  not  over-capitalized 
in  the  sense  that  the  par  value  of  the  bonds  and  stocks  issued 
exceeds  the  fair  value  of  the  property  represented  by  such 
securities.  I  believe  that  the  true  measure  of  the  value  of  a 
railroad  is  its  earning  capacity  and  the  degree  of  efficiency 
with  which  it  serves  the  public  and  that  a  railroad  is  over- 
capitalized when  for  any  reason  it  is  unable  to  earn  its  fixed 
charges  and  a  reasonable  dividend  on  its  capital  shares.  When 
a  railroad  is  unable  to  earn  the  interest  on  its  bonded  debt, 
the  evil  of  over-capitalization  corrects  itself,  either  through 
a  growth  of  its  traffic  or  through  bankruptcy  and  reorgani- 
zation. 

5.  I  do  not  think  it  advisable  to  limit  the  issuance  of 
capital  stock  at  par  for  money  or  property  of  the  actual  value 
of  the  par  of  the  stock  issued,  nor  to  require  that  all  bonds 
must  be  sold  at  not  less  than  par.  We  need  more  railroad 
mileage  in  this  country  and  the  limitation  would  prevent  or 
at  least  retard  its  construction  except  by  old  established  roads 
whose  credit  is  very  high.  Moreover,  the  limitation  would 
render  consolidations  and  reorganizations  so  difficult  as  to  be 
well-nigh  impossible. 

6.  I  can  see  no  objection  to  the  sale  to  stockholders  of 
new  stock  at  par,  when  the  old  stock  is  selling  above  par  in 
the  market.  The  distribution  of  the  premium  among  stock- 
holders is  in  the  nature  of  an  extra  di\'idend  and  an  induce- 
ment to  purchase  the  new  stock. 

7.  I  am  of  the  opinion  that  capitalization  of  betterments, 
additions,  and  extensions,  charged  in  the  past,  to  "Income" 


but  which  might  have  been  charged  to  "Capital"  is  improper. 
The  charge  to  "Income"  should  close  the  account,  otherwise 
there  will  be  room  for  manipulation  of  accounts. 

8.  I  am  of  the  opinion  that  the  physical  valuation  scheme 
does  not  deserve  serious  consideration.  It  rests  upon  the 
assumption  that  the  cost  of  a  railroad  is  identical  with  its  value 
and  that  such  value  can  be  obtained  by  ascertaining  the  original 
cost  of  the  road  or  the  cost  of  replacing  the  property,  that  the 
results  can  be  used  as  a  criterion  of  the  reasonableness  of  rates 
and  that  such  rates  can  be  established  so  as  to  give  each  road  a 
reasonable  return  on  the  property  used  in  the  public  service. 
Every  one  of  these  assumptions  is  fallacious.  The  value  of  a 
road  can  be  measured  only  by  its  earning  capacity.  The 
original  cost  and  the  cost  of  reproduction  have  no  relation  what- 
ever to  railroad  rates,  nor  can  such  rates  be  established  for  each 
road  so  as  to  give  it  a  reasonable  return.  Railroads  have  been 
located,  constructed  and  are  being  operated  under  conditions 
that  vary  within  wide  limits.  Hence,  rates  cannot  be  made  that 
will  give  each  road  a  reasonable  retiim  on  the  property.  Ob- 
viously, all  roads  that  compete,  either  directly  or  through  com- 
petition between  markets,  must  have  the  same  rates.  Any  one 
who  is  familiar  with  railroad  transportation,  knows  that  the 
idea  of  basing  rates  on  valuation  of  the  property  of  railroads,  or 
on  capitalization  is  repugnant  to  common  sense.  It  is  not  only 
impossible  to  arrive  at  any  just  valuation  by  the  proposed 
methods,  but  the  results  obtained  at  great  expense  of  time  and 
money  cannot  serve  any  useful  purpose.  The  valuation  scheme 
probably  originated  in  an  erroneous  interpretation  of  the  de- 
cision of  the  United  States  Supreme  Court  in  the  case  of  Smyth 
vs.  Ames,  it  being  assumed  that  "a  reasonable  return  upon  the 
fair  value  of  the  property  used  in  the  public  service,  is  the  only 
element  to  be  considered  in  determining  the  reasonableness  of 
rates,  although  the  court  in  that  case  distinctly  says  that  it  is 
only  one  of  the  nimierous  elements,  some  of  which  it  specifies." 
The  erroneous  interpretation  has  proved  a  fruitful  source  of 
error  in  the  investigation  and  decisions  of  rate  cases.  This  is 
particularly  true  of  cases  involving  the  reasonableness  of  rates 
made  by  state  legislatures  and  State  Railway  Commissions, 


where  railroads  have  practically  no  other  defense  than  to  en- 
deavor to  show  that  such  rates  are  confiscatory,  they  have  to 
submit  evidence,  showing  that  certain  specific  rates  do  not 
cover  the  cost  of  transportation,  and  a  reasonable  return  on  that 
part  of  the  property  which  is  used  and  that,  therefore,  such 
specific  rates  are  confiscatory  and  in  violation  of  the  constitu- 
tion. While  such  evidence  can  be  obtained  as  to  the  entire 
traffic  of  a  railroad,  it  is  impossible  to  ascertain  the  cost  of  any 
specific  shipment  or  of  conducting  any  branch  of  the  transpor- 
tation service,  nor  the  value  of  the  property  used  in  such  service. 
This  is  so,  because  no  rational  method  has  as  yet  been  devised 
for  apportioning  the  operating  expenses  and  the  value  of  the 
property  used  among  the  several  services  rendered  by  the  rail- 
road. The  reasonableness  of  specific  rates  cannot  be  deter- 
mined by  ascertaining  whether  the  revenue  derived  from  the 
entire  traffic  yields  the  company  a  fair  return.  Such  return 
may  be  fair  in  the  aggregate,  and  yet  many  of  the  individual 
rates  or  rates  on  whole  classes  may  be  unreasonably  high  or 
unreasonably  low.  In  fact,  they  may  be  so  low,  as  to  be  con- 
fiscatory. 

In  the  Virginia  Maximum  Passenger  Rate  case,  the  Cor- 
poration Commission  went  so  far  as  to  express  the  opinion  that 
it  was  not  the  question  of  reasonableness  of  rates,  but  the 
reasonableness  of  revenue  that  is  involved  in  rate  cases,  and  that 
the  Commission  is  at  liberty  to  make  any  reduction  it  may  see 
fit  in  the  rates  on  any  articles  or  any  branch  of  service  it  may 
select,  provided  the  revenue  from  the  entire  traffic  is  sufficient 
to  give  the  road  what  the  Commission  may  deem  a  reasonable 
return  on  the  property  used. 

The  Maximum  Passenger  Rate  case,  decided  April,  1907, 
b}-  the  State  Corporation  Commission  of  Virginia  and  the  order 
of  the  Railroad  Commission  of  Kentucky  governing  rates  on 
general  merchandise  in  the  case  of  the  Commonwealth  of  Ken- 
tucky vs.  the  Louisville  &  Nashville  Railroad  Company,  et  al. 
affords  striking  illustrations  of  the  fallac}'^  of  the  theory  that  the 
valuation  of  railroad  property  can  be  used  as  a  basis  for  deter- 
mining the  reasonableness  of  rates  and  of  capitalization.  These 
decisions  show  that  any  result  that  may  be  desired  in  the  matter 
of  value  of  property  used,  and  the  return  on  such  value  can  be 

6 


obtained  by  the  adoption  of  suitable  methods  of  valuation,  and 
of  the  apportionment  of  operating  expenses  and  the  value  of 
property  among  the  several  services  rendered  by  a  railroad.  It 
is  in  my  opinion  difficult  to  escape  the  conclusion  that  the  theory 
of  reasonable  retiun  on  the  fair  value  of  the  property  used  is 
fallacious  and  impracticable  of  application.  As  a  matter  of 
fact,  railroad  companies  are  not  entitled  to  a  reasonable  return 
on  the  fair  value  of  the  property  used.  They  are  entitled  only 
to  what  they  can  earn,  be  it  much  or  little,  by  charging  rates 
that  are  just,  reasonable,  and  undiscriminatory,  the  reasonable- 
ness of  rates  being  determined  by  commercial  and  competitive 
conditions  and  the  value  of  the  service  to  the  shipper  and  to  the 
railroad. 

9.  Some  of  the  proposed  methods  of  valuation,  while 
having  the  appearance  of  scientific  analysis,  necessarily  resolve 
themselves  into  guess  work.  Of  course,  such  so-called  valuation 
can  be  made  by  any  Federal  agency. 

10.  The  Interstate  Commerce  Commission  is  overwhelmed 
with  work,  Congress  having  already  imposed  duties  upon  it 
without  regard  to  its  physical  ability  to  properly  perform  them. 
To  give  the  Commission  supervision  and  control  over  the  issu- 
ance of  stocks  and  bonds  would  enormously  increase  its  work. 
Heretofore,  the  Commission  has  decided  cases  by  careful  in- 
vestigation of  all  the  facts  and  circumstances  that  bear  upon  the 
question  of  reasonableness  of  rates.  The  question  arises,  will 
it  be  able  to  continue  this,  the  only  fair  method,  if  it  were  given 
supervision  practically  to  a  large  extent  over  the  finances  of  the 
railroad?  Is  it  not  to  be  feared  that  the  Commission  would 
avail  itself  of  an  official  valuation  as  a  short-cut  to  the  deter- 
mination of  rate  questions?  This  seems  to  me  to  be  the  only 
use  that  could  be  made  of  the  valuation  scheme,  but  such  use 
cannot  be  considered  as  legitimate,  because  the  Act  to  Regulate 
Commerce  requires  that  decisions  must  be  based  upon  proper 
investigation. 

I  have  endeavored  to  answer  the  questions  in  the  order  in 
which  they  are  propounded,  expressing  my  opinions  without 
supporting  them  at  length  by  facts  and  arguments. 


In  compliance  with  the  request  that  I  furnish  the  Com- 
mission with  any  of  my  views  that  have  been  printed,  I  herewith 
enclose  copies  of  two  chapters  of  a  monograph  I  wrote  in  1907 
(about  the  time  the  question  of  valuation  of  railroads  was  first 
agitated),  on  the  "Valuation  of  Railroad  Properties  as  a  Basis 
for  Regulation  of  Rates."  One  of  these  chapters  treats  of 
"Over-capitalization",  the  other  of  "Valuation  of  Raih-oad 
Properties."  They  were  published  by  the  Railway  Age  Gazette 
in  July,  1908. 

The  following  are  some  of  the  conclusions  I  reacted,  upon 
nvestigation  of  the  subject: 

I. 

The  value  of  the  property  used  has  no  direct  relation  to 
rates;  hence,  rates  caimot  be  based  upon  such  value,  nor  can 
the  reasonableness  be  ascertained  upon  the  basis  of  such  valua- 
tion. 

II. 

The  value  of  railroad  property  cannot  be  determined  by  a 
physical  valuation.  The  only  measure  of  value  that  can  be 
properly  applied  is  the  earning  capacity. 

III. 

The  earning  capacity  depends  on  the  rates  that  can  be 
charged  and  on  the  volume  and  character  of  the  trafl&c.  The 
rates  depend  upon  commercial  and  competitive  conditions. 
The  volimie  and  character  of  traffic  depends  upon  the  location 
of  the  road  and  the  degree  of  success  which  has  attended  the 
efforts  of  the  company  to  develop  the  resources  of  the  cotmtry 
tributary  to  its  railroad. 

IV. 

There  is  no  recognized  basis  for  apportioning  the  value  of 
the  property  used  between  the  several  branches  of  the  service. 

V. 

The  value  of  the  property  used  in  any  branch  of  the  service 
(even  if  it  could  be  ascertained  upon  a  recognized  basis),  multi- 


plied  by  the  reasonable  percentage  of  profit,  is  no  criterion  of  the 
reasonableness  of  rates  on  such  branch. 

VI. 

Railroad  companies  are  not  entitled  to  a  reasonable  return 
on  the  value  of  the  property  used.  They  are  entitled  only  to 
what  they  can  earn,  be  it  much  or  little,  by  charging  rates  that 
are  just,  reasonable,  and  undiscriminatory,  the  reasonableness 
of  such  rates  being  determined  by  commercial  and  competitive 
conditions  and  the  value  of  the  service  to  the  shipper  and  to  the 
railroad. 

VII. 

Rates  adjusted  on  the  value  of  the  service  principle,  intelli- 
gently and  fairly  applied,  are  just  alike  to  the  railroad  and  to 
the  shipper. 

VIII. 

The  reasonableness  of  rates  can  only  be  determined  by  the 
facts  bearing  upon  each  particular  case.  Reasonableness  of 
revenue  is  a  legal  fiction. 

IX. 

The  profits  of  railroad  companies,  resulting  from  the  volume 
of  business  they  have  helped  to  create  and  such  reasonable 
rates  as  commercial  and  competitive  conditions  enable  it  to 
charge  cannot  be  restricted  to  the  usual  rate  of  interest  without 
doing  injustice  to  the  owners  of  such  properties. 

X. 

Unreasonable  rates  can  be  readily  corrected  under  existing 
laws.  The  Courts,  State  Commissions,  and  Interstate  Com- 
merce Commission  have  ample  power  to  make  such  corrections. 

XL 

Railroad  companies  have  not  the  power  to  charge  extor- 
tionate rates,  nor  is  it  to  their  interest  to  do  so.  Such  rates 
would  kill  their  business. 

9 


XII. 

The  underlying  error  of  the  demand  for  valuation  of  rail- 
road property  is  the  assumption  that  railroads  have  the  power 
to  fix  their  rates  and  that  they  exercise  it  so  as  to  produce  an 
unreasonable  return  on  the  capital  invested. 

XIII. 

The  statistics  pubhshed  by  the  Interstate  Commerce  Com- 
mission and  by  Poor's  Manual  for  1905,  show  that  American 
railroads,  with  few  exceptions,  have  not  earned  a  reasonable 
return  on  the  capital  invested. 

XIV. 

These  statistics  also  show  that  the  increase  of  capitalization 
has  been  invariably  accompanied  by  a  reduction  in  passenger 
and  freight  rates. 

XV. 

Justice  to  the  railroads  and  to  their  customers  requires 
that  the  reasonableness  of  rates  on  intrastate  traffic  be  deter- 
mined by  the  same  method  that  the  Interstate  Commerce  Com- 
mission and  the  Federal  Courts  employ  in  ascertaining  the 
reasonableness  of  rates  on  interstate  traffic ;  that  is  to  say,  upon 
the  facts  surrounding  each  particular  case. 

The  above  conclusions  are  based  mainly  on  my  own  exper- 
ience. It  may  not  be  amiss  to  state  that  I  have  been  contin- 
uously in  the  service  of  American  railroads  for  sixty  years. 

Yours  very  respectfully, 

(Signed)  HENRY  FINK. 


10 


APPENDIX 


Extracts  from  Monograph  Written  by  Henry 

Fink,  in  1907,  on  the  "Valuation  of 

Railroad  Properties  as  a  Basis 

for  Regulation  of  Rates." 


"  OVLR-CAPITALIZATION/' 
VALUATION  OF  RAILROAD    PROPERTY. 


OVER-CAPITALIZATION. 
BY  HENRY  PINK. 
Chairman  of  the  Board:   Norfolk  &  Western. 


The  term  capitalization  is  generally  applied  to  the  capital  shares,  and 
bonded  debt  combined,  although  the  latter  constitutes  a  debt,  and  is  in  no 
sense  part  of  the  capital  of  a  railroad  company.  The  reason  for  this 
misapplication  of  terms  probably  is  that  very^few  American  railroads  were 
built  from  the  proceeds  of  the  sale  of  their  capital  shares.  Nearly  all  of 
the  companies  were  obUged  to  use  their  credit  and  borrow  sufficient  money 
for  the  completion  of  their  roads,  and  to  issue  bonds  of  various  kinds  as 
security  for  their  debts.  It  is  presumed  that  the  money  so  borrowed  has 
been  honestly  invested  in  the  railroads,  and  is  represented  by  adequate 
property,  and  that  therefore  the  bonded  debt  may  be  considered  a  part 
of  capitalization.  The  term  over-capitalization  may  be  definied  in  several 
ways.     For  example: 

1.  When  a  railroad  corporation  has  not  received  an  equivalent  in 
cash  or  in  property,  for  the  par  value  of  its  stocks  and  bonds,  the  corpora- 
tion may  be  said  to  be  over-capitalized  to  the  extent  of  the  difference 
between  such  par  value  and  the  money  realized. 

2.  When  the  par  value  of  the  stock  and  bonds  issued  exceeds  the 
fair  value  of  the  property  represented  by  such  issues. 

3.  If  the  earning  capacity  is  the  true  measure  of  the  value  of  a  rail- 
road (as  I  beheve  it  is),  then  a  railroad  is  over-capitaUzed  when  for  any 
reason  it  is  unable  to  earn  its  fixed  charges,  and  a  reasonable  dividend  on 
its  capital  shares. 

According  to  the  last  definition,  the  capitaUzation  of  a  road  may  be 
very  low,  and  still  it  may  be  over-capitalized,  because  of  insufficient 

earnings. 

When  a  railroad  is  unable  to  earn  the  interest  on  its  bonded  debt,  the 
evil  of  over-capitalization  corrects  itself,  through  bankruptcy  and  reor- 
ganization. 

Whatever  definition  may  be  adopted,  it  is  necessary  to  discriminate 
between  over-capitalization  that  is  legitimate  because  unavoidable  and 
harmless,  and  over-capitalization  that  is  due  to  fraud  and  trickery  of 
dishonest  promoters,  and  which  carries  in  its  train  many  material  and 

moral  evils. 

Over-capitalization  in  the  sense  that  the  par  value  of  the  stock  and 
bonds  has  not  been  realized  is  obviously  unavoidable,  because  railroad 

12 


companies  which  have  to  borrow  money  must  necessarily  pay  what  the 
money  is  worth  at  the  time  they  borrow  it;  and  they  must  offer  induce- 
ments to  investors  by  agreeing  to  pay  a  high  rate  of  interest,  or  by  seUing 
their  securities  below  their  par  value.  The  amount  of  such  discounts 
must  vary  with  the  varying  credits  of  the  borrowing  companies.  It  follows 
that  except  in  cases  where  the  credit  of  a  railroad  is  exceptionally  high, 
there  must  always  be  some  "water"  in  stocks  and  bonds.  The  only  way 
to  prevent  this  would  be  to  prohibit  railroads  from  selling  their  securities 
below  par.     This,  of  course,  is  impracticable. 

The  history  of  the  early  days  of  American  railroads  furnishes  a  strik- 
ing illustration  of  the  fact  that  capitalization  has  no  direct  relation  to 
railroad  rates.  In  the  early  days  railroad  companies  generally  received 
par  value  for  their  stocks,  and  they  issued  no  bonds  until  a  basis  of  credit 
had  been  created  by  the  construction  of  a  part  of  their  roads  from  the 
proceeds  of  the  sale  of  the  stock.  In  many  cases  these  roads  were  built 
in  anticipation  of  the  future  needs  of  the  people.  The  traffic  which  was 
to  support  them  had  to  be  created.  The  charges  for  transportation  were 
very  high,  but  the  people  were  glad  to  avail  themselves  of  the  improved 
facilities,  and  did  demur  so  long  as  the  charges  did  not  equal  or  exceed 
those  by  wagon  or  river  and  canal  transportation.  The  charters  in  many 
cases  prescribed  maximum  rates,  which,  however,  were  much  greater  thtin 
the  traffic  could  bear.* 

Section  1242  of  the  Virginia  Code  of  1887  provides: 

"When  the  net  profits  of  any  company  heretofore  or  hereafter  incorporated,  which  may 
be  governed  by  this  chapter,  shall  be  such  that,  but  for  this  section,  dividends  might  be 
declared  out  of  the  said  profits  exceeding  the  rate  of  fifteen  per  centum  per  annum  on  the 
capital  stock  invested,  laws  may  be  passed  for  reducing  the  toll  of  the  company.  But  no 
law  shall  reduce  the  tolls  so  as  to  prevent  dividends  of  15  per  centum  per  annum,  within  30 
years  from  the  time  the  first  dividend  of  profits  of  the  said  company  was  declared,  or  so  as 
to  prevent  dividends  of  12  per  centum  per  annum  after  the  said  30  years  and  before  .SO 
years  from  the  same  time,  or  so  as  to  prevent  dividends  of  10  per  centum  per  annum  after 
the  said  SO  years.' ' 

As  state  and  federal  railroad  commissions  were  unknown  in  those 
days,  one  might  suppose  that  the  railroads  would  have  charged  such 
rates  as  might  have  given  them  a  reasonable  return  on  a  fair  value  of  the 
property  used.  But  experience  proved  otherwise.  Advances  in  rates 
resulted  in  diminished  traffic  and  earnings;  and  many  of  the  roads  were 
forced  into  bankruptcy.  In  these  cases  the  capitalization  was  low,  but 
nevertheless  the  roads  were  over-capitalized;  and  as  a  result,  the  capital 
invested  in  them  was  sunk  in  whole  or  in  part,  except  in  cases  where  the 
owners  were  able  to  invest  additional  capital  for  the  extension  of  their 
road  to  regions  which  aflforded  more  traffic.  In  such  cases  over-capi- 
talization was  corrected  by  an  increase  of  the  capital. 


•A  Kentucky  charter  of  1829  fixes  a  maximum  rate  of  3i  mills  per  100  pounds  for  a 
distance  of  20  miles  or  less;  3  mills  for  over  20  miles  and  under  60  miles,  and  2i  mills  for  60 
»nd  over  60  miles. 

A  Maryland  charter  of  1831  fixes  a  maximum  rate  of  3  cents  per  ton  per  mile. 

A  Georgia  charter  of  1827  fixes  a  maximum  of  25  cents  per  100  pounds  for  heavy 
articles  and  10  cents  per  cubic  foot  for  light  articles. 

13 


At  another  period  we  find  that  over-capitalization  by  the  issue  of 
stock  on  which  par  value  was  not  realized  became  the  recognized  method 
of  raising  capital  for  the  construction  of  railroads  through  the  undeveloped 
country  of  the  West  and  Middle  West.  In  some  cases  stock  was  given 
as  a  bonus  to  the  purchasers  of  the  company's  bonds.  This  was  neces- 
sary in  order  to  assure  capitalists  who  had  seen  one  railroad  after  another 
go  into  bankruptcy,  an  ample  reward  for  their  risks. 

At  one  time  it  was  a  common  practice  to  issue  stock  to  contractors 
in  part  payment  for  constructing  railroads.  Of  course  in  such  cases  the 
par  value  of  the  stock  was  not  realized. 

It  is  often  asserted  that  the  payment  of  stock  dividends  contributes 
to  over-capitalization  or  stock-watering.  This  is  true  only  when  such 
payments  are  based  upon  false  accounting,  or  other  deceptive  methods. 
In  such  cases  the  practice  must  be  classed  with  fraudulent  over-capitali- 
zation. When  based  upon  an  honest  accounting,  the  stock  dividend 
shares  represent  earnings  which  were  expended  on  the  property,  instead 
of  being  divided  in  cash  among  the  shareholders. 

It  is  frequently  pointed  out  that  the  issue  of  stocks  and  bonds  in  pay- 
ment for  railroads  which  have  passed  through  bankruptcy,  and  are  reor- 
ganized, results  in  over-capitalization.  This  may  be  and  often  is  the  case; 
but  it  does  not  follow  that  such  over-capitaHzation  is  illegitimate  or  harm- 
ful. One  of  the  main  objects  in  reorganizing  a  railroad  company  is  to 
cut  down  its  fixed  charges  so  as  to  bring  them  within  the  earning  capacity 
of  the  road  during  periods  of  lowest  business  depression.  In  order  to 
attain  this  object  owners  of  certain  mortgage  bonds  of  the  old  company 
agree  to  accept  bonds  of  the  new  company,  but  to  a  less  amount  as  to 
principal,  and  frequently  at  a  reduced  rate  of  interest.  In  consideration 
of  this  sacrifice  of  capital  and  interest,  they  receive  certain  stocks  upon 
which  dividends  are  payable  only  when  a  revival  of  business  and  the 
growth  of  the  traffic  enable  the  new  company  to  earn  such  dividends. 
And  stocks  so  issued  are  in  no  sense  fictitious.  They  represent  actual 
values,  and  are  drafts,  for  value  received,  on  more  prosperous  times.  In 
many  cases  such  drafts  have  been  honored.  A  good  illustration  of  this  is 
afforded  by  the  result  of  the  second  reorganization  of  the  Norfolk  & 
Western  Railroad  Company  in  1896. 

After  the  first  reorganization  in  1881,  millions  of  dollars  were  expended 
in  improving  and  extending  the  road,  and  in  furnishing  increased  trans- 
portation faciHties  to  the  public.  Private  persons  and  corporations  also 
invested  millions  in  manufacturing  and  mining  enterprises  along  the  line 
of  the  road.  But,  unfortunately,  the  development  of  the  country  did 
not  keep  pace  with  these  investments.  Many  of  the  enterprises  came  to 
grief;  and  the  railroad  company,  being  unable  to  earn  its  fixed  charges, 
was  put  into  the  hands  of  receivers  for  the  second  time,  in  1895. 

At  the  reorganization  in  1896  the  new  company  issued  $62,500,000 
of  first  mortgage  4  per  cent,  bonds,  to  be  used  as  follows: 


14 


A.  $23,322,675  to  be  used  to  provide  for  the  disturbed  bonds  of  the 
old  company  and  to  carry  out  the  plan. 

B.  $25,986,889  to  be  reserved  for  the  purpose  of  taking  up  or  paying 
the  undisturbed  bonds  at  their  maturity. 

C.  $3,500,000  to  be  reserved  or  deposited  in  trust,  subject  to  suitable 
restrictions,  for  the  purpose  of  taking  up  or  paying  any  existing  obligations 
which  shall  not  be  taken  up  or  paid  out  of  funds  received  by  the  committee, 
and  for  other  necessary  purposes  of  the  new  company. 

D.  $9,690,436  to  be  reserved  for  the  construction  or  acquisition  of 
side-tracks,  second-tracks,  branches,  and  equipment,  and  for  other  improve- 
ments and  additions  to  the  property  covered  by  the  first  consolidated 
mortgage,  and  for  other  requirements  of  the  new  company;  but  such 
bonds  are  to  be  issued  only  subject  to  suitable  restrictions  to  be  prescribed 
in  the  mortgage  securing  the  same,  and  at  a  rate  not  exceeding  $1,000,000 
for  each  fiscal  year  after  June  30,  1896  (the  first  fiscal  year  being  that 
ending  June  30,  1897);  it  being  understood  that  any  portion  of  such 
$1,000,000  of  bonds  remaining  unissued  in  any  one  fiscal  year  may  be 
added  to  the  amount  which  may  be  issued  in  subsequent  years. 

It  also  issued  $23,000,000  of  4  per  cent,  non-cumulative  adjustment 
preferred  stock — shares  of  $100  each — and  $66,000,000  of  common  stock — 
shares  of  $100  each.  The  shareholders  of  the  common  stock  of  the  old 
company  were  required  to  pay  an  assessment  of  $12.50  per  share  for 
participating  in  the  reorganization  and  retaining  their  interest  in  the  road. 

The  following  table  will  show  the  scaling  down  of  the  disturbed 
securities  and  the  issues  and  percentage  of  stock  to  such  security  holders 
as  compensation: 

Per  cent,  received  in. 

.  oi 

C  C 

O  o  M 

DISTURBED  SECURITIES.  -S  1^5  " 

Adjustment  mortgage  7  per  cent,  bonds 7  130  20 

100-year  mortgage  bonds 62i  75 

Maryland  &  Washington  dividend  bonds 70  67} 

Clinch  Valley  dividend  bonds 50  70 

Equipment  mortgage  bonds  of  1888 100  48 

5  per  cent,  debentures  of  1892 . . , 100 

Roanoke  &  Southern  Railway  Co.  bonds 55  65 

Lynchburg  &  Durham  Railroad  Co 35  65 

N.  &  W.  Railroad  common  stock *75 

N.  &  W.  R.  R.  pf.  stock,  on  payment  of  $12.50  per  share  deposited 112J 

Roanoke  &  Southern  Ry.  stock,  on  payment  of  $12.50  per  share 

deposited 75 

Lynchburg  &  Durham  R.  R.  Co.  stock,  on  payment  of  $12.50  per 

share  deposited 75 

*Common  stock  above  75. 


15 


There  can  be  no  doubt  that  in  1896  the  road  was  largely  over-capi- 
talized, in  the  sense  that  the  earnings  were  insufficient  to  pay  fixed  charges 
and  dividends  on  the  capital  shares.  No  one  dreamed  that  any  dividends 
could  be  paid  on  the  common  stock  for  many  years;  hence  it  sold  in  the 
market  at  very  little  above,  and  at  times  below,  the  $12.50  per  share  of  cash 
assessments.  But  owing  to  the  revival  of  business  and  the  ensuing  un- 
exampled prosperity  of  the  country  and  the  great  development  of  the 
resources  of  the  region  traversed  by  the  road,  the  company  earned  and 
was  able  to  pay  a  dividend  of  1  per  cent,  on  its  adjustments  preferred 
stock  in  November,  1897,  a  like  dividend  in  February,  1898,  and  a  2  per 
cent,  dividend  in  August,  1898,  since  which  time  semi-annual  dividends 
have  been  paid  regularly  on  this  stock.  In  June  and  December,  1901, 
and  June,  1902,  dividends  of  1  per  cent,  were  paid  on  the  common  stock. 
From  and  including  December,  1905,  2  per  cent,  dividends  were  paid  on 
it  semi-annually  until  after  the  June  payment  of  1906,  and  since  December, 
1906,  dividend  payments  have  been  at  the  rate  of  5  per  cent,  per  annum, 
the  market  value  of  the  common  stock  at  times  approaching  closely  to  par. 

Fraudulent  over-capitalization  through  stock  issues  which  represent 
no  property  or  values,  and  made  for  the  purpose  of  affording  greater 
opportunities  for  speculation  or  gambling,  and  for  obtaining  or  retaining 
by  trickers  a  controlling  interest  in  the  road,  or  for  other  illegitimate 
purposes,  cannot  be  too  severely  condemned.  It  is  a  crime  differing  only 
in  degree  from  forgery  of  stock  certificates,  and  it  is  frequently  accompanied 
by  false  reports,  dishonest  accounting  and  other  misrepresentations  and 
methods  of  deception.  There  was  a  time  when  these  practices  obtained 
to  a  considerable  extent,  to  the  disgrace  of  the  railway  management  of 
this  country. 

Happily,  over-capitalization  of  this  sort  has  become  rare.  The  evil 
effects  resulting  from  it,  though  serious,  aflfect  share-holders  of  the  rail- 
roads concerned  more  than  they  do  the  public.  Generally  these  effects 
are  but  temporary,  because  the  operation  of  economic  laws  soon  results 
in  the  correction  of  the  evil.  Wall  Street  can  always  be  relied  upon  to 
promptly  squeeze  out  the  "water"  from  such  stocks. 

While  there  are  many  railroads  in  this  country  which  do  not  earn  an 
adequate  return,  even  in  times  of  great  prosperity,  there  are  few  which 
can  be  said  to  be  over-capitalized  in  the  bad  sense  of  the  term.  Certainly 
the  aggregate  capitalization  of  American  railroads  is  below  their  real  value. 
This  has  been  shown  by  the  history  of  these  railroads  and  by  comparison 
with  the  capitalization  of  railroads  in  England  and  on  the  continent  of 
Europe. 


16 


Prof.  H.  C.  Adams,  the  statistician  of  the  Interstate  Com- 
merce Commission,  states  on  Page  34  of  Eighteenth 
Annual  Report  on  the  Statistics  of  Railways  in  the 
United  States  for  the  year  ending  June  30,  1905, 

_      that  the  aggregate  amount  of  capitalization  of  all  the 

railroads  in  the  United  States  was $13,805,258,121 

But  on  Page  55  he  says  that  this  amount  overstates  the 
capital,  as  it  does  not  allow  for  an  admittedly  proper  de- 
duction of  amounts  of  stocks  and  bonds  in  other  rail- 
roads which  are  owned  by  the  railroads  themselves, 
and  on  Page  58  he  says  such  amounts  were: 

Stocks $2,070,052,108 

Bonds 568,100,021 

2,638,152,129 


Leaving  the  real  aggregate  capitalization $11,167,105,992 


On  Page  99  of  the  report  he  gives  the 
cost  of  all  the  roads  in  the  United 
States  as $11,170,458,581 

And  of  their  equipment 780,890,368 

11,951.348,949 


Excess  of  cost  over  capitalization $784,242,957 

It  will  thus  be  seen  that  the  capitalization  of  the  railroads  of  this 
country  is  less  than  their  cost  by  nearly  eight  hundred  million  dollars. 

And  as  will  be  seen  from  the  following  figures  taken  from  the  Report 
on  Transportation  Routes  and  Systems  of  the  World,  issued  by  the  Depart- 
ment of  Commerce  and  Labor  at  Washington,  the  capitalization  of  the 
European  railroads  is  much  in  excess  of  that  of  the  railroads  of  this  country : 

CAPITAL  OR  COST,  PER  MILE  OF  RAILROADS. 

1904  United  States $55,261 

1904  Canada 60.504 

1899  Uruguay 52.756 

1904  Venezuela 70.972 

1903  Germany 98.443 

1903  Austria 128.334 

1903  Hungary 74.045 

1903  Belgium  (state  roads  only) 160.893 

1902  France 137.601 

1903  Switzerland 104.969 

1904  United  Kingdom 272,737 

1902  Russia 78,553 

1902  Finland 32.189 

1904  Norway 38,371 

1904  Sweden  (state  railroads) 44,669 

1902  Sweden  (private  railroads) 22.006 

1902  Italy    108,212 

The  issue  of  railroad  stocks  is  subject  to  the  regulation  of  the  states 
which  created  the  corporations  through  the  original  charters  or  by-laws  en- 
acted subsequently.    For  instance,  in  Virginia  the  Corporation  Commission, 

17 


and  in  New  York  the  Public  Utilities  Commission,  have  power  to  regulate 
such  issues.     The  constitution  of  Illinois,  adopted  in  1870,  provided: 

"No  railroad  corporation  shall  issue  any  stock  or  bonds  except  for  money,  labor  or 
property  actually  received  and  applied  for  the  purposes  for  which  such  corporation  was 
created,  and  all  stock  dividends  and  other  fictitious  increase  of  capital  stock  or  indebtedness 
of  any  corporation  shall  be  null  and  void." 

It  is  now  proposed  that  the  federal  government  assume  the  regulation 
of  such  matters;  and  as  the  commerce  clause  of  the  federal  constitution, 
when  stretched  to  its  utmost  limits,  may  not  prove  adequate  for  the  purpose, 
and  in  view  of  the  fact  that  an  amendment  to  the  federal  constitution 
involves  great  difficulties  and  delays,  it  has  been  suggested  that  the  seventh 
clause  of  Section  7  of  Article  1  of  the  constitution,  in  regard  to  post  roads, 
be  utilized,  and  that  by  means  of  a  new  construction  of  the  constitution  the 
federal  government  usurp  the  power  reserved  by  the  states.  This  regu- 
lation is  not  to  be  confined  to  railroads,  but  is  to  be  applied  to  all  "big 
corporations,"  whether  affected  by  the  pubhc  interest  or  not. 

It  will  be  seen  from  President  Roosevelt's  speeches  that  while  he  is  of 
the  opinion  that,  with  the  exception  of  some  isolated  instances,  American 
railroads  are  not  over-capitalized,  he  nevertheless  recommends  that  Con- 
gress make  provision  to  enable  the  Interstate  Commerce  Commission  to 
undertake  the  physical  valuation  of  each  and  any  road  in  the  country, 
whenever,  in  the  opinion  of  the  Commission,  such  valuation  of  any  road 
would  be  of  value  to  the  Commission  in  its  work.  It  is  not  unreasonable 
to  suppose  that  if  the  President  would  carefully  investigate  the  subject, 
he  would  find  that  in  view  of  the  obvious  fact  that  the  value  of  railroad 
properties  has  no  relation  to  the  rates,  and  cannot  be  used  as  a  criterion 
of  their  reasonableness,  such  valuation  cannot  be  of  any  value  to  the 
Interstate  Commerce  Commission  in  its  work.  He  will  also  find  that  the 
injuries  resulting  from  over-capitalization  to  the  wage-earner  and  to  the 
public,  which  is  concerned  in  the  rates  paid  by  the  shipper,  are  wholly 
imaginary.  It  is  true,  however,  that  the  Interstate  Commerce  Commission 
might  favor  an  official  valuation  of  the  railroads,  because  it  would  furnish 
a  convenient  justification  of  some  of  its  orders  that  carriers  make  radical 
reductions  of  individual  rates,  or  of  rates  on  whole  classes  of  business,  for 
so  long  as  the  earnings  derived  from  other  sources  of  traffic  can  be  shown 
to  be  sufficient  to  yield  the  carrier  what  may  be  considered  a  reasonable 
return  on  the  value  of  the  property  as  ascertained  by  the  official  valuation, 
it  would  be  impossible  for  the  carrier  to  appeal  to  the  federal  courts  for 
the  reversal  of  such  order  with  any  hope  of  success,  no  matter  how  un- 
reasonable th?  reduced  rates  ordered  by  the  Commission  might  be  in  and 
of  themselves. 

It  is  obvious  that  the  owners  of  the  railroads  would  have  no  redress 
when  an  order  of  the  Commission  deprived  them  of  a  reasonable  compen- 
sation for  services  rendered,  and  that  they  could  only  appeal  to  the  courts 
for  protection  in  cases  of  actual  confiscation  of  their  property. 

18 


The  President's  suggestion  that  the  clause  of  the  Constitution  grant- 
ing the  national  government  power  to  establish  post  roads,  by  necessary 
implication  confers  upon  the  federal  government  control  over  railroads, 
whether  their  business  is  intrastate  or  interstate,  derives  importance  from 
the  great  weight  his  opinions  have  with  the  people  and  with  their  repre- 
sentatives in  Congress  of  both  political  parties. 

The  question  of  effecting  changes  in  the  Constitution  by  construction, 
instead  of  by  amendment,  has  already  been  discussed  by  able  members  of 
of  the  legal  profession.  Our  concern  not  being  with  legal  questions,  but 
with  the  probable  practical  effect  of  proposed  measures  for  the  regulation 
of  railroad  rates,  we  will  briefly  consider  whether  any  additional  legislation 
having  for  its  purpose  the  enlargement  of  the  powers  of  the  federal  govern- 
ment, is  needful,  if  it  were  found  to  be  practicable. 

It  cannot  be  denied  that  a  dual  control  of  railroad  rates  by  the  states 
that  created  these  corporations  and  by  the  federal  government,  which 
obtains  control  through  the  commerce  clause  of  the  Constitution,  has  its 
serious  disadvantages.  In  many  cases  the  rates  between  points  within  a 
state  necessarily  affect  the  interstate  rates,  and  very  frequently  the  latter 
are  based  upon  the  former;  hence  it  may  be  said  that  in  such  cases  the 
state  and  the  federal  government  excercise  jurisdiction  over  the  same 
subject  matter.  The  fact  that  in  the  past  no  serious  difficulties  have 
been  experienced  from  this  dual  control,  is  due  in  part  to  the  success  which 
has  attended  the  efforts  of  traffic  men  to  adjust  rates  in  compliance  with 
the  requirements  both  of  state  and  federal  commissions,  but  more  particu- 
larly to  the  conservatism  that  has  marked  the  action  of  the  state  legislatures 
and  state  railroad  commissions.  Unfortunately  many  of  the  states  have 
in  recent  times  departed  from  that  conservative  policy.  They  have  not 
only  ordered  radical  reductions  in  rates  on  intrastate  traffic,  especially  in 
the  passenger  rates,  but  in  some  cases  are  enforcing  by  legislation  or 
through  state  railroad  commissions  certain  rules  and  regulations  in  the 
conduct  of  intrastate  business  that  must  affect  the  interstate  traffic  of  the 
roads. 

Much  of  the  legislation  referred  to  is  ill-advised,  and  in  its  results 
must  prove  detrimental  to  the  material  interests  of  the  states  that  enacted 
it.  The  writer  hopes  and  believes  that  when  the  people  begin  to  feel  the 
injurious  effects,  as  they  must,  sooner  or  later,  we  will  see  such  laws  as 
are  fraught  with  the  greatest  mischief  amended  or  abolished,  In  the 
meantime  it  is,  in  the  opinion  of  the  writer,  not  needful  or  advisable  for 
Congress  to  enlarge  the  powers  of  the  government  so  as  to  give  it  juris- 
diction over  intrastate  traffic.  This  opinion  is  based  upon  the  fact  that 
the  government,  under  the  Constitution  and  existing  laws,  has  already 
ample  power  to  regulate  rates  on  interstate  traffic,  even  though  intrastate 
rates  may  be  involved  in  such  regulation.  The  commerce  clause  was 
adopted  by  the  framers  of  the  federal  Constitution  for  the  avowed  purpose 
of  preventing  the  states  from  obstructing  traffic  between  the  states  and 
with  foreign  countries.     A  law  passed  by  Congress  under  that  clause  is 

19 


the  supreme  law  of  the  land,  and  a  violation  of  such  law  by  a  state,  whether 
directly  or  through  the  exercise  of  its  power  over  intrastate  traffic,  is 
unconstitutional,  and  will  be  so  declared  by  the  Supreme  Court  of  the 
United  States. 

In  view  of  recent  railroad  legislation  by  states,  the  management  of 
systems  which  traverse  six  or  more  states,  it  they  had  their  choice,  would 
naturally  elect  to  serve  but  one,  instead  of  six  or  more  masters.  However, 
at  the  present  stage  of  the  evolution  of  railroad  regulation,  the  discussion 
of  the  question  of  transferring  the  direct  control  of  intrastate  traffic  to  the 
federal  government  appears  to  be  purely  academic. 

The  suggestion  that  the  federal  government  assume  the  regulation 
of  stock  and  bond  issues,  in  order  to  prevent  over-capitalization  and 
protect  individuals  who  may  desire  to  invest  in  railroad  securities,  involves 
some  interesting  questions  as  to  the  legitimate  sphere  of  the  government's 
interference,  what  is  to  be  the  limit  of  such  interference  with  the  freedom 
of  the  individual,  and  what  human  action  should  remain  under  the  exclusive 
jurisdiction  of  the  individual. 

So  far  the  kind  of  socialism  which  proposes  to  use  the  power  of  the 
government  for  the  regulation,  not  only  of  production  and  consumption 
but  of  ever)'  detail  of  life,  for  the  purpose  of  neutralizing  the  effects  of 
innate  inequality  of  man.  has  not  found  favor  in  this  country.  Socialism 
of  this  kind  is  imported.  It  is  foreign  to  this  country,  and  cannot  flourish 
among  a  people  of  practical  common  sense  who  habitually  pay  more  attention 
to  facts  than  to  theories  based  on  mere  assumption.  It  is  true,  however,  that 
occasionally  men  occupying  high  positions  express  opinions  on  the  functions 
of  government  which  the  most  advanced  socialist  might  indorse,  but  these 
opinions  do  not  meet  with  general  acceptance.  Freedom  of  the  individual 
within  the  law,  that  is,  limited  individualism  and  equality  before  the  law, 
are  underlying  principles  of  American  governments.  It  may  be  said  that 
in  the  sphere  of  economy  the  government  poHcyhas  been  one  of  laissez 
faire.  Under  this  policy  the  country  has  grown  to  be  what  it  is,  and  it  is 
steadily  gaining  in  power  and  material  prosperity  because  of  the  large 
measure  of  liberty  and  the  wide  scope  given  to  individual  energy  and  skill 
in  the  development  of  its  immense  resources.  It  is  a  historical  fact  that 
the  opposite  policy,  that  oi  fueur  de  gouverner,  which  prevailed  in  France 
in  the  eighteenth  century,  nearly  strangled  every  branch  of  French  industn,-. 
and  brought  about  starvation  of  the  people. 

The  country  is  suffering  from  an  excess  of  railroad  regulation.  Much 
of  it  is  ill-considered.  In  many  cases  the  remedies  are  worse  than  the 
evils  they  are  designed  to  cure.  We  have  seen  that  the  best  remedy  for 
over-capitalization  due  to  insufficiency  of  earnings  to  pay  fixed  charges 
and  return  on  the  capital  stock  Hes  in  the  growth  of  the  volume  of  the 
traffic.  In  such  cases  a  restriction  of  the  issue  of  stock  cannot  affect  its 
intrinsic  value.  Its  market  value  is  determined  by  appraisements  made 
in  Wall  street,  and  such  appraisements  afford  a  better  protection  to  investors 
than  any  government  regulations.       Indeed  it  is  difficult  to  understand 


how  such  regulation  could  give  any  protection  at  all,  even  if  it  were  a 
function  of  government  to  protect  individuals  against  the  consequences 
of  their  own  errors  of  judgment.  That  over-capitalization  is  an  evil 
cannot  be  denied,  but  it  would  seem  irrational  to  shackle  commerce  and 
industry  and  their  instruments  by  an  attempt  to  abolish  by  legislation  an 
evil  which  is  corrected  by  operation  of  economic  laws. 


VALUATION  OF  RAILROAD  PROPERTY. 

BY  HENRY  FINK. 

Chairman  of  the  Board,  Norfolk  &  Western. 


No  definite  basis  o'  valuation  having  as  yet  been  determined,  we 
will  examine  as  briefly  a  ■  possible  some  of  ".he  method  which  have  been 
suggested  for  the  valuation  of  railroad  property. 

By  keeping  in  mind  the  use  that  is  proposed  to  be  made  of  this  valua- 
tion, the  reader  will  be  able  to  judge  for  himself  whether  these  objects 
can  be  accomplished  by  the  proposed  methods. 

PHYSICAL   VALUATION   BASED   ON   THE   ORIGINAL  COST   OF   THE    PROPERTIES. 

All  methods  of  determining  the  physical  valuation  of  railroad  prop- 
erties have  in  common  the  underlying  idea  that  the  terms  "cost"  and 
"value,"  when  applied  to  railroads,  are  synonymous.  By  the  method 
we  are  now  considering,  the  property  is  divided  into  its  constituent  parts, 
the  original  cost  of  each  part  being  determined  separately.  For  example, 
it  is  proposed  to  ascertain  the  original  cost  of  the  right  of  way,  depot 
grounds,  and  other  real  estate,  embankments,  cuts,  tunnels,  culverts, 
bridges,  ballast,  cross-ties,  rails,  switches,  station  buildings,  employees' 
buildings,  machine  shops,  office  buildings,  telegraph  line,  machinery, 
locomotives,  passenger  cars,  freight  cars,  etc.     To  the  aggregate  amount  of 

21 


this  original  cost  there  is  to  be  added  the  cost  of  all  the  property  which  has 
been  acquired  since  the  road  was  turned  over  to  the  company  by  the  con- 
tractors. Whether  the  condition  of  the  property  at  the  time  the  valua- 
tion is  made  is  to  be  taken  into  consideration,  and  a  deduction  is  to  be 
made  for  depreciation,  the  writer  does  not  know.  In  view  of  the  difficulty, 
and,  in  case  of  the  older  railroads,  the  impossibility  of  ascertaining  the 
original  cost,  and  the  cost  and  value  of  all  the  additions  that  have  been 
made  to  the  property,  it  is  proposed  to  make  a 

PHYSICAL   VALUATION    BASED   ON   COST   OF    REPRODUCTION. 

By  this  method,  the  property  is  also  divided  into  its  constituent 
parts;  but  the  value  of  each  part  is  ascertained  by  the  cost  of  reproducing 
it  at  prices  ruling  at  the  time  of  the  valuation. 

For  example:  Right  of  way,  depot  grounds,  and  other  real  estate 
is  valued  at  the  prices  of  adjoining  lands;  the  cost  of  graduation  and 
masonry  is  ascertained  from  the  prices  per  cubic  yard  for  which  such  work 
can  be  done  at  the  time  of  the  valuation.  As  the  quantities  and  classi- 
fication of  material  can  rarely  be  obtained  from  the  original  engineering 
notes,  it  will  be  necessary  to  put  engineering  parties  in  the  field  to  survey 
the  railroads,  cross-section  the  cuts  and  fills,  measure  the  bridges,  tunnels, 
etc.  A  careful  inspection  of  every  part  has  to  be  made  to  determine  the 
amount  of  depreciation.  For  it  is  the  cost  of  reproducing  the  property 
in  its  condition  at  the  time  of  its  valuation  which  is  to  be  ascertained. 
As  the  cost  of  materials  and  labor  fluctuates,  and  the  railroads  have  to 
add  constantly  to  their  property  in  order  to  furnish  adequate  facilities 
for  the  requirements  of  the  traffic,  it  follows  that  what  may  be 
a  fair  valuation  of  a  railroad  one  year  may  not  be  so  one  or  two  years 
later.  Hence,  it  would  be  necessary  to  make  new  valuations  from  time 
to  time.  The  proposed  method  is  the  same  as  that  adopted  since  1902 
by  the  Board  of  State  Tax  Commissioners  of  the  State  of  Michigan  for 
the  appraisal  of  railroad  properties  for  the  purpose  of  taxation. 

The  following  table  from  Bulletin  21  (on  the  "Commercial  Valuation 
of  Railways  Operating  Property  in  the  United  States,  1904"),  issued  by 
the  Department  of  Commerce  and  Labor  at  Washington,  will  give  the 
reader  a  good  idea  of  this  method: 

SUMMARY  OF  ALL  RAILROADS  IN  MICHIGAN. 

MILEAGE. 

Main  track 7.052.35 

Second  track 164.83 

Branches 730.92 

Spurs  and  sidings 2 ,904 .  70 


22 


VALUE  OF  PHYSICAL  PROPERTIES. 

Pr.  ct. 
Cost  of  re-         Present  of 

production  value  new 

1.  Engineering,  4  per  cent.,  items  2-25,  inclusive, 

and  33 $5,386,772  $5,386,772  100.0 

2.  Right  of  way  and  station  grounds 27,745,313  27,745,313  100  0 

3.  Real  estate 863,337  863,337  100  0 

4.  Grading 21.699,995  21,693,024  100.0 

5.  Tunnels 1,148,070  1,093.445  95  4 

6.  Bridges,  trestles  and  culverts 8,027,119  6,337.819  78.8 

7.  Ties  (cross  and  switches) 11,139.024  6,148,748  53  9 

8.  Rails 28,703.012  21,865.994  76.1 

9.  Track  fastenings 3,845,030  2,987,982  77.6 

10.  Frogs,  switches  and  crossings    1,469,721  1,040  120  71  0 

11.  Ballast 3.723,556  3,723',556  10o!o 

12.  Track  laying  and  surfacing 6,355,638  6,400,972  97  5 

13.  Fencing 2,763,595  1,627,790  58.8 

14.  Crossing,  cattle  guards  and  signs 607,542  428.474  70.4 

15.  Interlocking  and  signal  apparatus 501.683  448^686  89  3 

16.  Telegraph  (30  telephones) 258,985  134,797  52 .0 

17.  Station  buildings  and  fixtures 4.108.736  3,111,103  75.8 

18.  Shops,  roundhouses  and  turntables 2.157.228  1,467,569  68.2 

19.  Shop  machinery  and  tools 1.107,910  882,634  79  7 

20.  Water  stations 725.670  522.135  72  0 

21.  Fuel  stations 303.289  201,461  66.2 

22.  Grain  elevators 1,336.794  1,009,043  75  0 

23.  Warehouses 258.646  183.910  71  3 

24.  Docks  and  wharves 5,531,919  3,831.934  69.4 

25.  Miscellaneous  structures 1.234.345  856,253  69.4 

26.  Locomotives 9,021,517  5,092,053  66  4 

27.  Passenger  equipment 3,197,473  2,277,271  712 

28.  Freight  equipment 19,734,246  13,690.587  69.4 

29.  Miscellaneous  equipment 702.940  423,689  60.3 

31.  Ferries  and  steamships 1,725,300         1,095.500         63  5 

32.  Electric  plants 93,061  69,898         96 . 8 

33.  Terminals 

34.  Legal  expenses.   0.5   per  cent..    Items   2   to   25 

inclusive,  and  33 673,349  673,349       100.0 

35.  Interest,  3  per  cent..  Items  1  to  34,  inclusive 5,290,549         5,290.549        100.0 

36.  Miscellaneous  expenses: 

Organization,  1 .5  per  cent 2,645,277         2,645,277        100  0 

Contingencies,  10  per  cent 18,428,759       15,127,110         62.3 

Total  cost  of  construction  and  equipment .. .  $202,716,252  $166,398,156  81.4 

*Value  of  non-physical  properties 35.814,043 

Total    value    of    physical    and    non-physical 

properties $202,212,199 

37.  Stores  and  supplies 1,474,829         1,474,829         82.2 

♦Figures  furnished  by  Prof.  Adams. 

This  inventory  method  is  supplemented  by  a  consideration  of  the 
earning  capacity  of  the  roads,  and  in  the  same  Bulletin  will  be  found  an 
interesting  letter  from  Prof.  Henry  C.  Adams,  addressed  to  the  Michigan 
Board  of  State  Tax  Commissioners,  in  which  he  recommends  a  rule  for 
the  appraisal  of  non-physical  elements  of  corporate  property. 

PHYSICAL   VALUATION,   SUPPLEMENTED   BY   THE   PERSONAL   EQUATION, 
OR   METHOD   ADOPTED   BY   THE   VIRGINIA   COMMISSION. 

We  have  seen  that  in  fixing  the  maximum  value,  per  mile,  of  Virginia 
railroads,  the  commission  was  largely  influenced  by  the  property  principle 
by  direct  assessment — which  is  essentially  a  physical  valuation  principle. 
The  commission  says  in  respect  to  valuation  matters  that  it  knows  no  better 

23 


or  more  reliable  method  than  to  give  due  and  proper  consideration  and 
weight  to  the  following  matters,  among  others: 

"1.     The  original  cost  of  the  property,  so  far  as  it  is  shown. 

"2.  The  amount  of  the  capital  and  bonded  debt  of  the  company- 
applicable  to  the  property  in  this  state. 

"3.     The  market  value  of  such  stock  and  bonds. 

"4.     The  cost  of  reproducing  the  property  anew  so  far  as  it  is  shown. 

"5.  The  cost  of  reproducing  the  property  in  its  present  condition 
so  far  as  it  is  shown. 

"6.  The  properly  assessed  value  of  the  property  for  purposes  of 
taxation. 

"7.     The  personal  knowledge  of  the  property  by  the  commission." 

It  then  proceeds  to  say  that  "no  one  of  these  considerations  should 
control,  but  due  weight  should  be  given  to  each."  But  it  immediately 
afterward  observes  that  "the  original  cost  of  a  railroad  and  its  equipment 
is  often  unascertainable,  and  it  is  wholly  impracticable  to  ascertain  the 
cost  of  reproduction — either  new  or  in  its  present  condition,"  and  that 
"the  most  unreliable  and  misleading  of  all  the  foregoing  considerations 
is  the  amount  or  present  market  value  of  the  stock  and  bonds  of  the  road." 

This  would  seem  to  reduce  the  seven  matters  to  be  considered  to  only 
two;  that  is,  the  6th,  or  the  properly  assessed  value  of  the  property  for 
purposes  of  taxation,  and  the  7th,  the  personal  knowledge  of  the  property 
by  the  commission. 

It  should  not  require  any  argument  to  show  that  the  methods  above 
described  cannot  result  in  a  fair  valuation  of  property  for  any  purpose, 
because  the  principal  characteristic  of  a  purely  physical  valuation  is  gross 
inequality.  For  example:  The  cost  of  grading,  masonry,  bridges,  tunnels, 
etc.,  of  a  comparatively  new  railroad  built  through  a  mountainous  countiy 
may  be  five  times  greater  than  that  of  an  older  road  built  through  a  valley 
or  on  a  plain,  while  the  value  as  a  railroad,  measured  by  its  efficiency  to 
serve  the  public  and  the  volume  and  character  of  its  business,  may  not 
be  one-tenth  part  as  great  as  that  of  the  road  built  in  the  valley  or  on  the 
plain. 

The  underlying  error  of  the  method  is  that  cost  represents  value.  The 
cost  of  preparing  a  roadbed  for  the  track  adds  nothing  to  the  value  as  a 
railroad,  no  matter  what  its  cost  may  have  been.  The  advocates  of  a 
physical  valuation  impute  value  to  the  cost  of  things  which  contribute 
little  or  nothing  to  the  real  value  as  a  railroad,  and  they  disregard  the 
things  which  have  real  value;  that  is,  the  efficiency  as  an  instrument  of 
commerce,  and  the  degree  of  success  in  building  up  the  country'  and  develop- 
ing its  traffic  as  measured  by  its  earning  capacity. 

In  view  of  these  facts,  and  others  which  might  be  mentioned,  it  is 
impossible  to  escape  the  conclusion  that  a  physical  valuation  is  irrational 
in  principle,  and  impracticable  of  application. 


24 


VALUATION    BASED   ON   MARKET   VALUE   OF    BONDS   AND   STOCKS. 

Unlike  the  physical  valuation,  this  method  has  a  rational  basis.  The 
value  of  a  railroad  depends  on  its  net  earning  capacity,  and  the  market 
value  of  its  securities  under  normal  conditions  reflect  such  earnings,  as 
well  as  the  physical  condition  of  the  property  and  the  degree  of  efficiency 
with  which  it  is  able  to  serve  its  purpose  and  afford  safe,  regular,  expedi- 
tious and  cheap  means  of  communication  between  sections  of  the  country, 
and  especially  the  volume  and  character  of  the  traffic  it  has  been  able  to 
develop  in  the  course  of  years. 

Wall  Street  is  a  good  appraiser  of  values.  The  market  values  of 
stock  represent  the  best  judgment  of  thousands  of  men — investors  and 
speculators — who  make  it  a  business  to  study  railroad  problems  and  to 
keep  themselves  constantly  informed  of  all  the  conditions  which  influence 
or  affect  the  earning  capacity  of  the  roads.  It  is  true  that  prices  of  stock 
fluctuate — at  times  violently — but  this  difficulty  can  be  overcome  in  a 
measure  by  using  the  average  prices  for  long  periods,  such  periods  being 
judiciously  selected  with  reference  to  normal  conditions  of  the  market. 
No  doubt  this  method  would  give  good  results  when  applied  to  railroads 
which  have  been  in  operation  for  many  years,  in  old  and  well-developed 
sections  of  the  country,  for  generally  the  stocks  of  such  roads  are  bought 
largely  for  investment.  Their  prices  do  not  fluctuate  materially,  and 
owing  to  the  enhanced  value  of  real  estate  and  terminals,  the  value  of  the 
property  is  generally  greater  than  the  aggregate  market  value  of  the 
securities  representing  it.  But  it  is  different  with  comparatively  new 
roads,  which,  to  a  great  extent,  have  to  develop  the  business  which  is  to 
support  them,  and  also  with  the  newly  reorganized  companies.  In  these 
cases  the  method  of  valuation  based  upon  the  market  value  of  the  stocks 
and  bonds  would  not  give  satisfactory  results. 

THE   TRUE    MEASURE   OF   VALUE   OF    A    RAILROAD    IS    ITS   EARNING 

CAPACITY. 

Corporations  build  and  operate  railroads  for  the  purpose  of  earning 
dividends  for  their  stockholders  (if  they  can)  by  selling  transportation 
to  the  public.  The  value  of  a  railroad  depends  upon  the  degree  of  efficiency 
with  which  it  can  serve  its  customers.  This  efficiency  is  reflected  in  their 
earning  capacity  and  is  affected  by  various  conditions  and  circumstances — 
some  of  which  may  be  enumerated  as  follows: 

1.  Location  and  construction  with  reference  to  sources  of  traffic  and 
economy  of  operation. 

2.  Character  and  amount  of  transportation  facilities,  terminals,  etc. 

3.  Degree  of  success  of  the  efforts  to  develop  the  resources  of  the 
country  and  in  locating  commercial,  manufacturing,  mining,  and  other 
industries  which  afford  traflSc. 

4.  Volume  and  character  of  the  traffic. 

25 


5.  Conditions  affecting  the  value  of  the  service;  that  is,  the  rates 
of  transportation  which  can  be  charged  to  the  customers. 

6.  Competition  with  other  railroads,  water  lines,  and  between  markets. 

7.  Good-will  of  the  customers,  and  good  feeling  generally  of  tlie 
people. 

8.  Skill,  industry,  and  honesty  in  the  financial  and  physical  operation 
of  the  road. 

Some  of  these  conditions  affect  the  earning  power  more  than  others; 
but  all  of  them  are  reflected  in  the  net  earnings  of  a  road.  Therefore, 
the  net  earnings  are  the  true  measure  of  the  value  of  a  railroad.  The 
tnxth  of  this  cannot  be  successfully  controverted.* 

It  is  manifest  that  the  earning  capacity  cannot  be  considered  by  the 
advocates  of  valuation,  because,  as  the  Kentucky  Commission  observes 
in  respect  to  the  apportionment  of  the  annual  charge  for  valuation: 

"Certainly  neither  gross  earnings  nor  net  earnings  can  be  a  satisfactory  basis  of  appor- 
tionment of  these  charges  for  this  purpose, particularly  where  the  purpose  of  the  apportion- 
ment is  to  determine  the  propriety  of  the  rates  from  which  these  gross  earnings  and  net 
earnings  result.  In  this  case  the  earnings  result  from  the  rates  in  question.  This  annual 
charge  for  valuation  is  in  a  sense  part  of  the  carrier's  cost,  and  to  attempt  to  justify  the 
apportionment  of  costs  by  the  earnings  resulting  from  rates,  and  then  to  justify  the  rates 
by  the  apportionment  of  costs  based  on  the  earnings  resulting  from  the  rates,  would  clearly 
be  reasoning  in  a  circle.' ' 

The  commission's  reasoning  is  of  course  correct  from  its  standpoint, 
but  it  does  not  prove  that  earning  capacity  is  not  a  good  measure  of  value 
of  railroads.  It  merely  proves  the  fallacy  of  the  method  of  ascertaining 
the  reasonableness  of  rates  from  a  valuation  of  the  property  used. 

VALUATION   IS   NOT   NEEDED,    BECAUSE   RAILROADS   CANNOT   AND   DO 
NOT  CHARGE   EXORBITANT    RATES. 

One  object  of  the  valuation  is  to  prevent  railroads  from  charging 
exorbitant  rates.  The  remedy  is  not  needed  because  the  evil  does  not 
exist.  -  Existing  state  and  federal  laws  regulating  railroad  charges,  if 
properly  enforced,  afford  ample  protection  to  the  shipper.  But  even  if 
this  were  not  so,  railroad  companies  cannot  charge  exorbitant  rates,  because 
they  would  kill  their  business  and  put  themselves  into  bankruptcy. 

No  private  persons  or  corporations  that  are  "affected  with  public 
interests"  are  so  much  affected  by  pvtblic  prejudices  that  seek,  and  too 
often  find  expression,  in  ill-considered  legislation,  as  the  railroads  are.  For 
every  ill,  real  or  imaginary,  a  special  legislative  nostrum  is  prescribed. 
Thousands  of  railroad  bills  are  introduced  in  Congress  and  in  state  legisla- 
tures. The  remedies  proposed  are  more  numerous  than  the  patent  medi- 
cines which  are  advertised  as  panaceas  for  the  ills  to  which  the  natural 
person  is  subject.  Before  the  meeting  of  the  last  Congress  it  was  earnestly 
demanded  that,  in  order  to  cure  the  evil  of  rebating,  the  Interstate  Com- 
merce Commission  should  be  clothed  with  the  rate-making  power.  The 
pointing  out  of  the  obvious  fact  that  a  commission-made  rate  can  be 
rebated  as  easily  as  a  rate  made  by  the  railroads  made  no  impression  upon 
the  persons  who  demanded  such  legislation.     Nor  did  the  fact  that  the  Elkins 

26 


Act  had  been  on  the  statute  books  for  some  years,  which  law,  if  it  had 
been  properly  enforced,  would  have  stopped  rebating  long  ago.  At  a 
recent  session  of  Congress,  Senator  LaFollette  introduced  a  bill  providing 
for  the  official  valuation  of  all  the  railroads  in  this  country.  This  bill, 
however,  did  not  receive  the  approval  of  the  Senate  Committee  on  Inter- 
state Commerce.  Mr.  Bryan  strongly  advocates  the  valuation  of  railroad 
properties  by  the  Interstate  Commerce  Commission  and  by  the  various 
state  railroad  commissions.  As  we  have  seen.  President  Roosevelt  also 
advocates  the  valuation  of  the  railroads  by  the  Interstate  Commerce 
Commission.  The  wild  cry  of  "over-capitalization"*  is  raised  in  every 
section  of  the  country  and  the  physical  valuation  of  railroad  property  is 
demanded. 

To  make  a  valuation  of  all  the  railroads  would  require  years  of  labor 
and  the  expenditure  of  several  millions  of  dollars.  Owing  to  rapidly 
changing  conditions,  a  new  valuation  would  be  needed  before  the  preced- 
ing one  could  be  completed.  The  question  arises:  what  good  would  these 
valuations  do?     What  do  their  advocates  expect  to  accomplish? 

One  object  is  said  to  be  the  correction  of  the  evil  of  exorbitant  rates. 
As  stated  above,  this  remedy  is  not  needed  because  the  evil  does  not  exist. 
It  has  been  shown  repeatedly  that  while  the  passenger  rates  on  a  certain 
class  are  somewhat  higher  in  this  country  than  in  some  of  the  more  densely 
populated  countries  in  Europe,  the  American  freight  rates  are  the  lowest 
in  the  world. 

A  conclusive  answer  to  the  charge  that  rates  have  been  extortionate 
in  the  past  can  be  found  in  the  report  of  the  Interstate  Commerce  Com- 
mission to  the  Senate  Committee  on  Interstate  Commerce  in  reply  to  a 
resolution  of  the  Senate,  January  16,  1906.  This  report  shows  the  work 
of  the  commission  in  respect  to  complaints,  hearings,  and  decisions  of  the 
courts  as  to  exorbitant  and  unreasonable  rates,  etc.  It  appears  by  an 
extract  from  this  report  made  by  Joseph  Nimmo,  Jr.,  former  Chief  of  the 
Bureau  of  Statistics  in  the  Treasury  Department,  and  a  well-known  writer 
on  economics,  that  only  15  cases  involving  exorbitant  rates  were  decided 
by  the  courts  from  April  5,  1887,  to  March  1,  1905,  and  that  only  three  of 
these  cases  were  sustained  by  the  courts,  or  on  an  average  one  case  of 
exorbitant  rates  during  each  six  years  of  the  life  of  the  commission  up  to 
March,  1905. 

From  a  statement  made  by  Walker  D.  Hines,  in  his  testimony  before 
the  Senate  Committee,  it  appears  that  from  January  1,  1900,  to  January  I, 
1905,  the  commission  issued  13  orders  in  cases  of  unreasonably  high  rates, 
of  which  10  were  obeyed  by  the  carriers,  two  were  not  obeyed,  and  one 
was  not  sustained  by  the  court. 

The  Hon.  Martin  A.  Knapp,  Chairman  of  the  Interstate  Commerce 
Commission,  declared  several  years  ago  that  exorbitant  rates  were  practi- 
cally obsolete. 

An  inspection  of  the  following  table  will  show  that  the  freight  rates 
of  American  railroads  have  steadily  and  materially  decreased  since  1882: 

27 


Tons  hauled 

Av.  rate  per 

Tons  hauled. 

one  mile. 

ton  per  mile. 

360,490.375 

39,302,209,249 

1  .  236  cents. 

400.453,439 

44,064.923,445 

1  236  •• 

399,074,749 

44,725,207,677 

I  124  •• 

437,040,099 

49,151,894,469 

1  057  •• 

452,245,254 

52,802,070,529 

1  042  " 

552,074,752 

61.561,069,996 

I  034  " 

590,857,353 

65,423,005,985 

.977  " 

539,639,583 

68,727,223,146 

922  " 

636,541,617 

76,207,047,298 

941  " 

675,608.323 

81,073,784,121 

895   " 

706,555,471 

88.241,050,225 

.898  '• 

745,119,482 

93,588,111,833 

878  ■• 

638,186,553 

80,335,104,702 

.860  " 

696,761,171 

85.227,515.891 

.839  •' 

765,891,385 

95,328,360,278 

.806  " 

741,705,946 

95,139,022,225 

.798  " 

879,006.307 

114,077,576,305 

.733  " 

959,763,583 

123,667,257,153 

.724  •• 

1,101,680.238 

141,599.157,270 

.729  •• 

1,089,226,440 

147,077,136,040 

750  •' 

1,200,315,787 

157,289,370,053 

.757  '• 

1,304,394,323 

173,221,278,993 

.  763  " 

1,309,899,165 

174,522,089,577 

.780  " 

1,427,731,905 

186,463,109,510 

.766  •' 

Mileage 

Year.  operated. 

1882 104,971 

1883 110,414 

1884 115,704 

1885 123,320 

1886 125,185 

1887 137,028 

1888 145,387 

1889 157,758 

1890 163,597 

1891 168,402 

1892 171,563 

1893 176,461 

1894 178,708 

1895 180,657 

1896 182.776 

1897 184,428 

1898 186,396 

1899 189,294 

1900 193,343 

1901 197,237 

1902 202,471 

1903 207,977 

1904 212,577 

1905 217,017 

(The  above  figures,  1882  to  1888,  inclusive,  are  from  Poor's  Manual  for  1890.  The 
figures,  1889  to  1905,  inclusive,  are  from  the  annual  Statistics  of  Railways  in  the  United 
States,  issued  by  the  Interstate  Commerce  Commission.) 

*See  President  Roosevelt's  Indianapolis  speech. 

It  will  be  seen  that  during  the  23  years  from  1882  to  1905,  the  average 
rate  per  ton  per  mile  decreased  from  1.236  cents  to  .766  cents,  or  470,  or 
over  38  per  cent.  While  the  average  rates  per  ton  per  mile  do  not  show 
actual  reductions  in  individual  rates  or  classes,  because  of  the  varying 
proportions  of  low-rate  freights,  such  material  reductions  as  have  been 
made  are  necessarily  reflected  in  the  average  rates. 

The  Interstate  Commerce  Commission's  "Forty  Years'  Review  of 
Changes  in  Freight  Tariflfs"  contain  over  100  tables  showing  the  great 
reductions  that  have  been  made  in  individual  rates  both  competitive  and 
local. 

WHAT   IS   A   REASONABLE   RETURN   ON   THE    PROPERTY    USED? 

That  railroad  companies  are  entitled  to  a  reasonable  return  on  a  fair 
value  of  the  property  used  is  but  another  way  of  saying  that  every  laborer 
is  worthy  of  his  hire.  The  compensation  of  the  laborer,  be  he  one  who 
labors  with  his  hands,  or  a  professional  man,  is  determined  by  the  value 
of  his  services  to  his  emploj^er. 

The  services  of  railroad  corporations  have  a  distinctive  character, 
because  they  render  three  separate  services  to  the  public  for  which  they 
make  only  one  charge,  viz. : 

1.  As  proprietors  of  the  railroad. 

2.  As  transporters  or  common  carriers. 

3.  As  warehousemen. 

The  early  railroad  charters  in  England  and  in  this  country  contem- 
plated that  the  railroad  companies  furnish  the  roadway  and  throw  it  open 


28 


as  a  highway  for  the  use  of  the  public,  charging  tolls  for  such  use  in  the 
same  manner  in  which  canals  and  turnpikes  did.  If  this  idea  could  have 
been  carried  out  it  would  have  greatly  simplified  the  matter  of  reasonable- 
ness of  railroad  charges.  No  one  could  object  to  paying  the  proprietary 
company  such  reasonable  toll  as  might  enable  it  to  keep  the  road  in  a  safe 
condition,  and  to  earn  a  fair  profit  on  the  investment;  and  as  this  kind 
of  property  is  exposed  to  dangers  from  the  elements  and  deteriorates 
rapidly,  no  reasonable  person  would  limit  this  fair  return  to  the  ordinary 
legal  interest. 

If  transportation  were  furnished  by  a  separate  company,  it  would  be 
less  difficult  to  determine  the  value  of  the  services,  and  a  reasonable  return 
on  the  capital  invested.  But  in  that  case  the  extra-hazardous  nature  of 
such  investment  should  also  be  taken  into  consideration  in  determining 
what  is  such  reasonable  return. 

It  is  probable  that  if  railroad  accounts  were  kept  more  in  detail  with 
the  view  of  ascertaining,  with  a  closer  approach  to  accuracy,  all  the  factors 
which  affect  rates  of  transportation,  the  difficulties  of  ascertaining  the 
reasonableness  of  rates  under  the  varying  conditions  of  performing  the 
service  would  be  minimized.  At  all  events,  prevailing  misapprehensions 
on  the  subject  might  be  more  easily  corrected.* 

It  has  been  pointed  out  frequently  that  the  existing  confusion  in  the 
minds  of  the  people  on  the  subject  of  railroad  tariffs  arises  from  the  fact 
that  people  do  not  bear  in  mind  that  railroad  charges  are  made  up  of  three 
distinct  services,  and  that  a  single  measure  cannot  be  applied  to  them. 

There  are  hardly  any  two  railroads  in  this  country  which  were  built 
or  are  operated  under  the  same,  or  even  similar  circumstances  and 
conditions.  Therefore,  a  fixed  rate  of  profit,  or  an  inflexible  rule,  applied 
to  all  railroads,  would  result  in  injustice  and  unjust  discrimination. 

There  is  a  great  diversity  in  the  earning  capacity  of  different  rail- 
roads— in  their  location,  construction,  gradients,  alinement,  density  of 
traffic,  and  other  important  factors  determining  the  net  earnings  of  rail- 
roads. These  factors  vary  within  wide  limits.  What  would  be  a  fair 
return  to  the  owners  of  one  railroad  may  not  be  to  those  of  another  railroad, 
whose  volume  and  character  of  traffic  is  materially  different.  Moreover, 
the  earning  capacity  of  railroads  varies  within  wide  Hmits  during  different 
periods.     Hence,  what  may  be  a  reasonable  return  during  times  of  great 


•The  Hepburn  Act  provides  that  the  Interstate  Commerce  Commission  may  prescribe 
the  formg  of  any  and  all  accounts,  records  and  memoranda  to  be  kept  by  carriers,  including 
the  accounts,  records  and  memoranda  of  the  movement  of  traffic,  as  well  as  the  receipts  and 
expenditures  of  moneys.  This  provision  of  such  Act  prohibits  under  heavy  penalties  (of 
not  less  than  $1,000  nor  more  than  $5,000,  or  imprisonment  for  a  term  of  not  less  than  one 
year  nor  more  than  three  years,  or  both  such  fine  and  imprisonment)  [keeping  any  other 
accounts,  records  or  memoranda  than  those  prescribed  or  approved  by  the  Commission. 

While  the  uniformity  of  railroad  accounts  is  very  desirable,  the  unwisdom  of  prohibiting 
railroad  companies  from  keeping  ancillary  accounts  is  apparent  from  the  fact  that  the  con- 
ditions as  to  operation  and  traffic  are  not  the  same  on  any  two  roads  in  the  country,  and 
Information  which  may  be  of  value  to  the  operating  officers  of  one  railroad  may  be  entirely 
valueless  to  those  of  another.  It  is  gratifying  to  learn  that  the  Interstate  Commerce  Com- 
mission in  issuing  its  orders  putting  the  law  into  efiFect  has  tempered  this  provision  with 
common  sense,  by  allowing  railroad  companies,  at  least  until  otherwise  directed,  to  keep 
inch  ancillary  accounts. 

29 


prosperity  might  be  wholly  inadequate  during  times  of  business  depression. 
Therefore,  a  uniform  maximum  rate  of  profit  cannot  be  fixed  by  law,  unless 
the  government  guarantees  such  profit  for  all  time — and  this,  of  course, 
cannot  be  done. 

May  not  these  considerations  account  for  the  fact  that  the  courts  have 
not  established  a  basis  for  the  valuation  of  railroads,  nor  fixed  a  percentage 
of  profit  ("reasonable  return")?  That  this  percentage  cannot  be  justly 
restricted  to  the  legal  rate  of  interest  is  manifest  from  the  fact  that  owing 
to  the  hazardous  nature  of  investments  in  railroads,  they  cannot  be  deemed 
analogous  to  investments  in  commercial,  industrial,  and  other  enterprises. 

We  know  from  experience  that  a  large  portion  of  the  capital  invested 
in  railroads  in  this  country  has  either  been  unproductive  for  a  number  of 
years  or  has  proved  a  total  loss.  The  traffic  of  railroads  is  fluctuating. 
There  are  long  periods  of  depression  of  business,  when  rates  have  to  be 
reduced  in  order  to  enable  shippers  to  send  their  commodities  to  the 
markets,  and  when  many  railroads  can  barely  earn  their  interest  charges, 
and  the  stockholders  can  receive  no  dividends.  It  would  therefore  be 
unfair  to  confine  shareholders  to  a  fixed  rate  of  profit  when  a  revival  of 
business  enables  the  company  to  earn  more  than  the  established  maximum. 

Railroads  cannot  suspend  operations  during  times  of  business  depres- 
sion, nor  transfer  their  plants  to  other  points,  as  manufacturers  can  do. 
Their  operation  is  continuous;  and  as  a  large  part  of  their  operating 
expenses  have  to  be  incurred  anyhow,  regardless  of  the  volume  of  business, 
they  cannot  materially  reduce  their  operating  expenses  when  the  traffic 
diminishes. 

Their  properties  are  exposed  to  great  dangers  from  the  elements. 
Cloudbursts  in  the  mountains  and  swollen  streams  frequently  destroy 
hundreds  of  thousands  and  even  millions  of  dollars  worth  of  property,  and 
necessitate  a  suspension  of  operations  for  days,  weeks,  and  even  months. 

Railroad  properties  depreciate  very  rapidly.  Some  portions  are  from 
time  to  time  rendered  of  little  or  even  no  value  by  the  revision  of  grades  and 
alinement,  by  the  adoption  of  modern  improvements  in  machinery  and  safety 
appliances,  etc.  Railroads  sustain  heavy  losses  from  excessive  awards  of 
damages  in  cases  of  accidents,  many  of  which  are  unavoidable  so  long  as 
the  human  equation  enters  into  the  operation  of  railroads.  The  construc- 
tion of  parallel  lines  may  at  any  time  materially  affect  the  earning  capacity 
of  a  road.  And  not  the  least  of  the  dangers  to  which  railroads  are  exposed 
is  ill-considered  legislation  by  states  and  the  federal  government,  at  times 
when  the  waves  of  popular  prejudices  sweep  over  the  land. 

Capital  is  keenly  alive  to  these  dangers.  It  may  be  asked,  who  would 
have  invested  in  American  railroad  securities  if  the  rate  of  interest  had 
been  confined  to  the  legal  rates  in  the  several  states?  And  who  is  Hkely 
to  furnish  in  the  future  the  capital  necessary  to  build  new  roads  and  to 
enlarge  transportation  facilities  now  so  heavily  overtaxed,,  if  the  returns 
on  the  capital  is  to  be  restricted?  There  are  many  other  opportunities  to 
earn  the  legal  interest,  or  more,  where  ample  security  can  be  obtained  for 

30 


the  regular  payment  of  interest,  as  well  as  of  the  principal.  Capital 
invested  in  hazardous  enterprises  must  necessarily  receive  a  large  rate  of 
profit  as  a  reward  for  the  risk.  Investments  in  railroads  are  in  a  measure 
speculative.  Investors  expect  to  receive  not  only  a  reasonable  rate  of 
interest,  but  also  a  share  of  the  advantages  which  fiow  from  the  growth 
of  the  country  and  from  the  skill  and  industry  of  the  management.  Why 
deny  them  the  fruits  of  their  skill  and  industry  in  the  management  of  the 
property,  or  deprive  them  of  an  increment  in  the  value  of  the  property  due 
to  the  development  of  the  country? 

RAILROAD  CAPITALIZATION   AND   RETURN   THEREON. 

A  suggestive  comparison  of  freight  and  passenger  rates,  and  the  return 

on  stocks  and  bonds  during  the  past  twenty-three  years  is  brought  forth 

in  the  following  table: 

Earnings  Per- 

Average  rate  per  mile  of  road  centage 

Per  cent.  Per  mile,  eta.  in  operation  of  exp.  to 

Year.        Interest.     Dividends.    Per  ton.      Per  pass.        Gross.  Net.  earninga. 

1883 4.94  2.76  1.224  2.422  17.405  $2,679  63.82 

1884 4.82  2.50  1.124  2.356  6,663  2,318  65.22 

1885 4.97  2.00  1.057  2.199  6,209  2,163  65.17 

1886 4.86  2.02  1.042  2.194  6.570  2.376  63.83 

1887 4.86  2.17  1.034  2.276  6,799  2,418  64.44 

1888 4.48  1.80  0.977  2.246  6,540  2,045  68.72 

1889 4.53  1.79  0.970  2.169  6,446  2,066  67.95 

1890 4.44  1.82  0.927  2.174  6,875  2,166  68.50 

1891 4.41  1.87  0.929  2.184  6,851  2.135  68.83 

1892 4.25  1.93  0.941  2.168  6,852  2.068  69.82 

1893 4.31  1.88  0.893  2.072  6,963  2,069  70.29 

1894 4.19  1.66  0.864  2.025  6,054  1,803  70.22 

1895 4.24  1.58  0.839  2.069  6,097  1,804  70.41 

1896 4.45  1.52  0.821  2.032  6,233  1,840  70.43 

1897 4.24  1.51  0.797  2.029  6,228  1,884  69.74 

1898 4.21  1.71  0.758  1.994  6,771  2,111  68.16 

1899 4.26  1.92  0.726  2.002  7,161  2,272  68.27 

1900 4.27  2.44  0.746  2.031  7,826  2.519  68.93 

1901 4.24  2.65  0.756  2.028  8,270  2,668  67.73 

1902 4.10  2.97  0.764  2.012  8,696  2.830  67.45 

1903 4.17  3.03  0.781  2.052  9,301  2,887  68.96 

1904 4.01  3.31  0.787  2.053  9,248  2,989  67.68 

1905 3.79  3.27  0.789  2.030  9,643  3,135  67.49 

It  will  be  seen  that  the  highest  average  rate  of  dividend  was  3.31  per 
cent,  in  1904,  and  the  lowest  1.51  per  cent,  in  1897.  The  two  tables  also 
furnish  conclusive  refutation  of  the  theory  that  capitalization  has  any 
relation  to  rates  and  that  increased  capitalization  must  result  in  an  increase 
of  rates.  It  will  be  seen  that  the  capitalization,  including  stock  and  bonded 
debt,  increased  from  $5,402,038,257  in  1880  to  $14,563,199,931  in  1905, 
or  170  per  cent.,  and  that  during  the  same  period  the  average  rate  per  ton 
per  mile  decreased  from  1.224  cents  to  0.789  (cents,  or  35  per  cent.,  and 
that  the  passenger  rates  decreased  from  2.422  cents  per  passenger  per  mile 
in  1880  to  2.030  cents,  or  16  per  cent. 

It  will  also  be  seen  from  the  accompanying  tables  taken  from  the 
Interstate  Commerce  Commission  "Statistics  of  Railways  in  the  United 
States"  for  the  decade  ended  June  30th,  1905,  that  during  that  period  of 
exceptional  prosperity,  shareholders,  with  few  exceptions,  did  not  re- 
ceive a  reasonable  return  on  their  investment. 


31 


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RATE  MAKING  ON  THE  BASIS  OF  VALUATION  OF  PROPERTY  IS  IMPRACTICABLE. 

The  Virginia  and  Kentucky  cases  furnish  a  striking  illustration  of 
the  impracticability  of  government  rate-making  on  the  basis  of  Evaluation 
of  property. 

Let  us  assume,  for  further  illustration,  that  a  railroad  commission 
has  to  establish  freight  tariffs  for  road  A,  built  in  a  mountainous  country, 
and  at  a  cost  of  $50,000  per  mile;  and,  also,  for  road  B,  built  in  a  valley 
or  on  a  plain  at  a  cost  of  $25,000  per  mile. 

We  assume  further  that  there  are  important  industrial  establishments 
on  both  roads,  which  produce  the  same  articles  and  ship  them  to  the  same 
markets.  A  tariff  for  road  A  that  is  25  per  cent,  higher  than  that  for 
road  B  must  be  considered  as  reasonable,  both  on  account  of  the  greater 
value  of  the  property  used,  and  the  probable  greater  cost  of  operation.  But 
what  would  be  the  result  of  such  tariff?  Obviously,  road  A  would  have 
reasonable  rates;  but  road  B  would  get  all  the  competitive  freights.  The 
industrial  estabUshments  on  road  A  would  have  to  be  closed.  As  the 
commission  could  not  order  road  B  to  advance  its  rates  (such  advance 
might  enable  that  road  to  earn  more  than  a  reasonable  return  on  a  fair  value 
of  the  property  used),  it  must  say  to  road  B:  the  rates  we  fix  for  you  are 
maximum  rates.  You  can  charge  as  much  less  as  you  please.  That  would 
solve  the  problem;  but  what  would  become  of  the  theory  of  rate-making? 

Owing  to  the  interdependence  of  rates,  what  is  true  of  roads  A  and  B 
is  equally  true  of  other  roads  in  different  sections  of  the  country.  Com- 
munities that  are  served  by  roads  of  small  capitalization  would  have  lower 
rates  than  those  which  are  not  so  fortunate.  The  result  would  be  unjust 
discrimination  against  localities,  and  hopeless  confusion  and  disaster  to 
commercial  enterprises  which  depend  on  railroad  transportation.  Ulti- 
mately the  roads  which  have  the  lowest  capitalization  would  fix  the  rates 
for  all  the  other  roads  in  the  same  section,  with  which  they  compete 
either  directly  or  indirectly,  by  competition  between  markets.  This 
might  mean  bankruptcy  to  many  railroads,  unless  they  could  make  up 
for  their  losses  on  competitive  business  by  putting  heavier  burdens  on  the 
local  or  non-competitive  traffic. 

The  theory  of  rate-making  on  the  basis  of  valuation  of  property  ought 
to  commend  itself  to  the  advocates  of  government  ownership  of  railroads; 
for  no  more  effective  plan  for  depreciating  the  value  of  railroad  securities 
could  be  devised.  As  a  basis  for  rate-making  this  theory  may  be  charac- 
terized as  "the  sublimity  of  absurdity,"  to  borrow  a  phrase  which  Presi- 
dent Roosevelt  applied  to  another  matter. 

VALUE-OF-SERVICE   PRINCIPLE. 

About  forty  years  ago,  a  friend  of  mine,  then  superintendent  of  a 
Virginia  railroad,  was  asked  by  the  chairman  of  an  investigating  committee 
of  the  Virginia  Legislature,  "Why  does  your  company  charge  $1  per  bale 
of  cotton  from  local  station  A  on  your  road  to  the  terminal  station  B?" 

33 


He  answered  promptly,  "Because  we  can  get  it."  A  shout  of  derisive 
laughter  followed,  and  the  chairman  added:  "Oh!  you  charge  all  you  can 
get,  do  you?" 

The  newspapers,  and  even  some  railroad  men,  did  not  fail  to  cast 
ridicule  upon  my  friend,  and  yet  he  had  stated  in  a  few  words,  probably 
without  being  aware  of  it,  the  underlying  principle  of  all  railroad  tariffs, 
and  of  the  tariffs  of  tolls  that  applied  to  canals  and  turnpikes  hundreds  of 
years  before  railroads  were  dreamed  of. 

It  is  apparent  that  under  no  circumstances  can  a  railroad  charge  a 
shipper  more  than  such  shipper  is  able  to  pay.  It  does  not  follow,  how- 
ever, that  rates  are  made  on  a  basis  of  charging  all  a  shipper  can  afford  to 
pay.  Such  a  basis  would  be  unfair,  because  it  would  deprive  the  shipper 
of  his  equitable  share  of  the  value  created  by  the  transportation.  Hence, 
the  rate  would  not  represent  the  fair  value  of  the  service  to  the  shipper. 
But  the  rate  must  also  be  fair  to  the  railroad.  Hence,  it  follows  that  the 
fair  value  of  the  service  is  determined  by  what  the  shipper  is  able  to  pay 
to  yield  him  such  profit  as  he  is  willing  to  accept,  and  what  the  railroad 
can  afford  to  render  the  service  for.  A  railroad  and  a  shipper  may  be  said 
to  be  in  partnership  limited  to  each  particular  shipment.  The  shipper 
furnishes  the  article  and  the  railroad  the  transportation,  the  profit  from 
each  transaction,  that  is,  the  earned  increment  of  value  created  by  the 
service,  to  be  equitably  divided  between  these  partners.  The  first  ques- 
tion to  be  determined  is,  can  the  article  be  transported  at  all?  If  the 
shipper's  share  of  the  value  created  by  the  service  gives  him  no  profit  at 
all,  and  the  railroad's  share  does  not  reimburse  it  for  the  expense  of  hand- 
ling and  moving  the  article,  then  the  service  is  practically  of  no  value, 
and  the  article  cannot  be  transported.  For  example:  If  we  assume  that 
the  increased  value  of  an  article  by  reason  of  transportation  from  the  point 
of  production  (A)  to  the  market  (B)  would  be  equivalent  to  20  cents  per 
100  pounds,  and  the  actual  outlay  of  the  railroad  for  handling  and  moving 
the  article  was  22  cents  per  100  pounds,  then  the  service  is  of  no  practical 
value,  and  the  article  cannot  be  carried.  If,  however,  the  shipper's  share 
yields  him  such  minimum  profit  as  he  may  be  willing  to  accept,  and  the 
railroad's  share  gives  it  something  more,  however  little,  than  the  expense 
of  moving  and  handling  the  article,  then  the  service  is  of  some  value, 
which  may  be  designated  the  minimum  value,  and  the  article  can  be  trans- 
ported. The  minimum  value  in  such  a  case  fixes  the  maximum  rate  that 
particular  article  can  bear. 

For  instance:  If  the  increase  of  value  created  by  the  transportation 
should  be  equivalent  to  30  cents  per  100  pounds,  and  the  expense  of  hand- 
ling and  hauling  is  22  cents  per  100  pounds,  then  a  rate  can  be  fixed  which 
will  give  some  profit  to  the  shipper,  and  give  to  the  railroad  something 
over  the  actual  expense  of  handling  and  hauling.  It  follows  that  the  rate 
must  not  be  higher  than  the  article  can  bear — the  value  of  the  service 
being  determined  by  the  ability  to  pay.  This  ability  varies  within  wide 
limits  with  different  articles,  according  to  their  values.     For  instance: 

34 


Silks  and  dry  goods  can  bear  higher  rates  than  pig  iron;  manufactured 
goods  can  generally  bear  higher  rates  than  the  raw  materials  out  of  which 
they  are  made.  Railroads  classify  their  articles  in  accordance  with  the 
rates  each  article  can  bear,  and  for  the  purpose  of  so  adjusting  rates  that 
every  article  contributes,  in  addition  to  the  expense  of  movement,  such 
proportion  of  the  expenses  of  maintenance  of  way,  track,  bridges,  buildings, 
general  administration  and  taxes,  and,  if  practicable,  interest  on  the 
capital  invested,  as  the  value  of  the  service  enables  each  article  to  con- 
tribute. 

The  underlying  principle  of  railroad  classification  is  discrimination 
between  different  classes  of  freight  in  accordance  with  the  value  of  the 
service  and  expense  of  operation.  We  will  now  see  whether  this  theory 
can  be  applied  to  the  practical  work  of  rate  adjustment. 

It  may  be  said  that  a  railroad  favorably  located  in  respect  to  the 
sources  of  its  traflSc,  and  economically  built  and  operated,  should  yield  to 
its  owner  a  fair  return  on  the  capital  actually  invested,  and  that  rates 
should  be  so  fixed  that  each  article  of  freight  carried  over  the  road  should 
pay  the  cost  of  its  transportation,  and  in  addition  thereto,  an  equitable 
proportion  of  the  fixed  charges,  and  of  the  dividends  to  be  paid  to  the 
stockholders.  But  the  cost  of  transporting  any  article  of  freight  is  not 
known  and  cannot  be  ascertained;  nor  can  the  amount  and  character  of 
the  traffic  which  has  to  be  assessed  with  these  charges  be  known  in  advance. 
Moreover,  the  principles  which  should  govern  the  equitable  distribution 
of  such  charges  remain  to  be  discovered.  But  assuming  that  freight 
rates  can  be  made  according  to  this  theory,  it  might,  and  probably  would 
be  found  that  they  were  in  many  cases  higher  than  the  rates  in  effect 
on  a  competing  railroad  or  water  line — so  that  the  rates  made  upon  mathe- 
matical principles  and  according  to  rules  of  equity  would  be  of  no  practical 
use. 

As  the  value  of  service  theory  is  correct,  the  above  example  merely 
shows  that  this  method  of  application  is  impracticable.  This,  however, 
does  not  affect  the  correctness  of  the  value  of  service  principle. 

How,  then,  are  freight  tariffs  made? 

It  cannot  be  said  that  they  are  made  in  the  sense  that  they  are  prod- 
ucts of  manufacture.  It  would  be  more  correct  to  say  that  they  are 
products  of  evolution.  One  generation  transmits  them  to  the  next,  with 
such  additions  and  modifications  as  traffic  conditions  necessitated.  It 
would  be  interesting  to  trace  the  development  of  modern  freight  tariffs 
from  the  simple  rate  sheets  of  the  earliest  days  of  railroads,  to  the  modem, 
highly  organized  tariffs,  with  their  elaborate  classifications  embracing 
thousands  of  articles,  and  to  note  that  influence  and  effect  of  surrounding 
circumstances  that  from  time  to  time  necessitated  modifications  and 
additions — and,  especially,  the  effect  of  increasing  competition.  Unfor- 
tunately, the  information  which  would  be  necessary  to  make  such  a  study 
is  not  obtainable. 

It  cannot  be  said  that,  in  modern  times,  railroads  make  tariffs;   they 

36 


can  only  adjust  them  to  varying  conditions.  This  work  is  performed  by 
a  department  known  as  the  traffic  department  or  commercial  department. 
Rate  adjusting  is  not  a  science,  but  a  profession  taught  in  the  school  of 
experience.  The  proficiency  of  traffic  men  can  only  be  acquired  by  many 
years  of  practical  work  in  the  several  branches  of  the  service.  Generally 
traffic  men  grow  up  with  their  respective  railroads,  and  are  familiar  with 
the  commercial  and  economic  conditions  of  the  country  tributary  to  their 
respective  railroads.  They  are  in  close  touch  with  the  public,  either 
directly  or  through  their  numerous  assistants — division  freight  agents, 
station  agents,  and  soliciting  agents.  By  being  in  close  touch  with  ship- 
pers they  can  acquaint  themselves  with  their  needs  and  requirements. 
It  has  been  said  that  traffic  men  should  know  the  business  of  shippers 
almost  as  well  as  the  shippers  do  themselves.  These  traffic  men  are  also 
in  close  touch  with  the  transportation  departments  of  their  respective 
roads,  and  keep  themselves  informed  of  the  movement  of  traffic  and  the 
factors  which  influence  the  economy  of  movement.  They  know  whether 
the  road  is  being  worked  to  its  full  capacity,  or  whether  it  is  desirable  to 
increase  the  volume  of  business  and  thus  reduce  the  expenses  of  operation. 
Adjusting  freight  rates  is  practical  work  for  men  who  have  special 
training  for  it  and  large  experience.  They  may  not  all  be  able  to  explain 
underlying  principles,  such  as  the  value  of  service,  but  they  have  used  this 
principle  for  years,  and  apply  it  intuitively  in  every  case  which  comes 
before  them.  Indeed,  it  has  become  with  them  a  habit  to  apply  it — not 
unlike  the  lawyer  who  is  called  upon  to  give  opinions  on  questions  involving 
facts  and  the  law,  the  traffic  man  is  called  upon  to  decide  rate  questions 
with  promptitude,  upon  the  facts  and  the  law,  according  to  his  best  judg- 
ment. He  must  be  familiar  with  commercial  and  economic  laws,  as  well 
as  state  and  interstate  laws  regulating  rates.  It  is  apparent  that  in 
adjusting  rates,  or  in  making  new  rates  when  it  is  within  their  power  to 
do  so,  these  traffic  men  decide  what  is  an  equitable  division  between  the 
railroad  and  the  shipper,  of  the  increment  of  value.  Frequently  his 
decision  results  from  bargaining  and  compromise.  But  generally  it  is 
arbitrary.  Hence,  laws  regulating  railroad  rates  are  imperatively  neces- 
sary, to  give  the  shipper  relief  in  case  of  errors  of  judgment  of  railroad 
men.  While  decisions  of  railroad  men  are  necessarily  arbitrary,  it  should 
be  borne  in  mind  that  railroad  men  appreciate  the  importance  of  treating 
their  customers  fairly,  and  of  fostering  and  developing  the  business  of  their 
roads.  Railroad  men  can  no  more  disregard  the  interests  of  the  shipper 
than  those  of  the  railroads  they  represent.  The  saying  that  the  interests 
of  the  railroads  and  the  public  are  identical  is  trite,  but  true.  The  present 
laws  afford  ample  protection  to  the  shipper  and  to  the  railroads,  except, 
as  we  have  seen,  in  the  case  of  state-made  tariffs. 

VALUE  OF  SERVICE  THE  CORRECT  STANDARD  OF  REASONABLENESS  OF  RATES. 

The  standard  of  reasonableness  of  rates  must  fulfill  the  following 
conditions : 

36 


1.  It  must  be  based  upon  correct  principles.  The  measure  to  be 
applied  must  have  direct  relation  to  the  thing  to  be  measured. 

2.  It  must  be  in  harmony  with  the  underlying  principles  of  practical 
rate  adjustment. 

3.  The  method  of  applying  the  standard  in  determining  the  reasona- 
bleness of  a  rate  must  be  practicable. 

We  have  seen  that  neither  the  theory  of  cost  of  transportation,  nor 
of  the  fair  value  of  the  property  need  comply  with  any  of  these  requisites. 
I  believe  that  the  value  of  service  is  the  correct  standard  of  reasonableness 
of  rates;  the  principle  constitutes  a  basis  for  judging  rate  questions  that 
is  broader  and  sounder  than  that  now  being  used.  It  will  clear  the  com- 
plex question  of  rate  adjustment  of  irrelevant  matter,  and  greatly  simplify 
it.  Of  course,  it  cannot  be  made  the  basis  of  a  formula  for  general  appli- 
cation. Each  case  must  be  determined  by  itself  on  its  merits  according 
to  the  facts  and  the  law  bearing  upon  it  in  the  same  manner  as  the  Inter- 
state Commerce  Commission  and  the  courts  do  in  cases  arising  under  the 
Act  to  Regulate  Commerce. 

I  believe  that  the  value  of  service  principle  fairly  and  intelligently 
applied  would  result  in  conclusions  that  are  just  to  the  shipper  as  well  as 
to  the  railroad. 


37 


3  0112  062004384 


